The Basics of Alternative Investment Funds!

The growth in the alternative investment market in India has been spectacular, to say the least. Institutional and HNI Investors have continued to pour money into Alternative Investment Funds (AIFs) over the last 3 years. The total commitments raised by the AIFs stands at INR 70,255.52 crores as on December 31, 2016. With equity markets doing reasonable well and expected to do even better, this surge in the investments in Alternative Assets reflect a maturing investor base. Globally by 2020, assets in alternative investments are expected to grow to US$18.1 trillion, from $10 trillion today.

As for the market players, with 288 AIFs already registered with SEBI and at least 20 more in the application stage, the competitive landscape in alternatives is expected to get very fierce. However, in contrast to traditional asset management, the alternatives market remains highly fragmented, with ample room for new category leaders to emerge.

While institutional investor portfolios have been witnessing a significant tilt towards alternative investments for some time now, it is the individual investors (High Networth Individuals, Families and Family Offices) in India who have surprised many with their appetite for this emerging asset class. A portfolio of traditional assets like equity & fixed income has the risk and return limitations. Investors are increasingly looking to alternative investments since they offer the potential for enhanced return from a broader, non-traditional investment approach while reducing overall portfolio risk. The AIFs on their part, up and above the access to alternative investments and strategies seek to deliver the three Ts: Transparency, Tradability, and Tax efficiency.

For investors, alternatives offer different risk and return characteristics than traditional assets, and often the opportunity for higher yields. Educated investors are increasingly warming up to the modern portfolio theory, which emphasizes the importance of diversifying holdings among asset classes, sub-asset classes, markets and instruments in a bid to generate superior returns and minimize risk. While traditional assets may still comprise the bulk of most investors’ portfolios, alternative asset allocation is beginning to play an interesting cameo by diversifying a portfolio, mitigating risk, increasing returns and last but not the least offering attractive tax benefits.

Alternative Investment Funds (AIFs)

On 21 May 2012, India’s capital market regulator, Securities and Exchange Board of India (SEBI), notified the Alternative Investment Funds (AIF) Regulations, 2012. This is in line with the global trend of carving out a new set of regulations for alternative assets. For instance, in April 2009, the European Commission had proposed a directive for alternative investment fund managers at the European level. This regulation, termed as ‘Alternative Investment Fund Manager’s Directive’ or AIFMD recently became operational on 22 July 2013.

In the Indian context, AIF means any fund established in India in the form of a trust, company or limited liability partnership which is a privately pooled investment vehicle and is not covered under the SEBI’s Mutual Funds (MFs) Regulations or Collective Investment Schemes (CIS) Regulations. Thus, AIFs offer a new way of investing in India, separate from the MF or CIS route.

The AIF regulations have been designed keeping in mind the unique needs of both investors and investees in alternate asset classes that are not necessarily mainstream. The funds registered as venture capital funds under SEBI’s Venture Capital Funds Regulations shall continue till their normal wind up but all new funds and schemes will now be launched under the AIF regulations.

Investor Eligibility

The AIF regulation places no restriction on the type of investors that can invest in AIF schemes as long as the issuance is through private placements. As per SEBI regulations, AIF may raise funds from any investor whether Indian, foreign or non-resident Indians by way of issue of units. RBI issued Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) (Eleventh Amendment) Regulations on November 16, 2015 as per which, Person resident outside India (‘PROI’) including a Registered Foreign Portfolio Investor (‘RFPI’) and Non-Resident Indian (‘NRI’) may invest in the units of AIFs. The said regulations also specified that if the Sponsor and Manager are domestically owned and controlled, downstream investments by the AIF will not be considered as foreign investments.

As per IRDA circular IRDA/F&I/CIR/INV/172/08/2013, insurers in India are permitted to invest in Social Venture funds, SME funds, Venture Capital fund, and infrastructure fund under Category I AIFs. Life Insurance Companies are permitted to invest up to 3% of their overall portfolio in AIFs and not more than 10% of any AIF corpus size while for General Insurance Companies the respective exposure limits are 5% and 10% respectively.

Investment ticket size and scheme size

Each scheme of an AIF must have a corpus of at least twenty crore rupees. Also, an AIF cannot accept from any investor an investment of value less than one crore rupees. Units of AIFs can only be issued through private placement and each scheme of an AIF cannot have more than a thousand investors.

Structure Details

Co-investment requirement for Sponsor/Manager

The AIF regulation mandatorily requires the Sponsor or Manager (both Sponsor and Manager can be the same entity in an AIF) to always have a continuing interest in the AIF. This continuing interest has been defined as 2.5% of the fund corpus or Rs. 5 crore whichever is less. Thus, under an AIF, the interests of the investors are aligned with the interests of the Sponsor/Manager.

Listing

Units of close-ended AIFs may be listed on stock exchange subject to a minimum tradable lot of one crore rupees. Listing of AIF units is permitted only after the final close of the fund or scheme.

Other details of AIF scheme

Within an AIF, multiple close-ended schemes can be launched with a minimum maturity of at least 3 years. Category III AIFs can be both open-ended and close-ended. The subscription to any scheme has to be through a private placement.

Comparison with Mutual Funds

 

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