Understanding Alternative Investment Assets in Detail

The alternative investment market in India is experiencing a remarkable expansion. From 2022 to 2023, its assets under management (AUM) soared by 30%, escalating from US$78 billion to an impressive $101 billion. Globally, the alternative investment market is expected to reach $21.1 trillion by 2025.

And why not? Alternative assets have proven their mettle and provided good returns to investors over the years. More and more investors will flock to this market and allocate some proportion of their portfolio to alternative assets like private equity, private debt, venture capital, real estate and others.

In this chapter, we’re going to explore how alternative investment funds work in detail.

Imagine a pool where various investors, both individual and institutional, gather their resources. This pool is an Alternative Investment Fund. It is an exclusive club where members can bring their funds to be invested collectively in non-traditional assets. These can range from real estate and hedge funds to private equity, commodities, and even art.

Now, as you can imagine, there are certain eligibility criteria that investors have to fulfil in order to be a member of this club. These can range from the minimum investment amount to the duration of the investment.

This entire fund amount is managed as a whole by experienced fund managers. The objective, of course, is to maximise returns for the investors while keeping the risk exposure as low as possible.

These are fairly similar to mutual funds, but there are certain key differences. For starters, AIFs involve a much larger minimum investment amount. Apart from that, these funds also enjoy more flexibility over the investment strategy and portfolio allocation.

In India, SEBI implemented the AIF Regulations in 2012. This was a significant move to acknowledge these funds, including Private Equities and Venture Capital Funds, as a separate asset class, distinctly different from promoter holdings, creditors and other public investors.
The importance of AIFs can’t be overstated. They offer investors a chance to venture into markets and strategies that are not available through conventional investment routes.

Category 1

1. Angel Funds

   Angel Funds focus on investing in emerging start-ups, at an earlier stage than Venture Capital Funds. These investors, known as angel investors, not only provide capital but also business management expertise.

   The minimum investment per angel investor typically stands at Rs 25 lakh, making these funds accessible to a broader range of investors interested in nurturing start-ups.

2. Venture Capital Fund (VCF)

   Venture Capital Funds specialise in investing in early-stage companies with high growth potential. These funds are crucial for new-age firms requiring substantial capital during their nascent stages. VCFs are more known for providing value addition as compared to Angel Funds.

   VCFs are known for their high-risk, high-reward approach. Investors, often High Net Worth Individuals (HNIs), allocate resources to VCFs, eyeing significant returns. The dynamic nature of these investments makes VCFs a vibrant part of the AIF landscape.

3. Infrastructure Funds

   These funds invest in infrastructure-related companies, such as those involved in constructing railways or ports. Investors bullish on infrastructure development tend to gravitate towards these funds. They offer a way to contribute to and benefit from the growth in infrastructure sectors.

4. Social Venture Funds

   Social Venture Funds invest in businesses that prioritise social responsibility. While they have a philanthropic angle, they also aim to generate decent returns for investors. These funds represent a growing interest in sustainable and socially responsible investing.

Category 2

1. Private Equity Funds

   Private Equity Funds invest in private, unlisted companies. These companies can range from younger companies emerging from the VCF ecosystem to established companies. Private Equity investments typically have a fund life ranging from 7 to 10 years, with extensions of 2 years.

2. Debt Funds

   Debt Funds primarily invest in debt securities of unlisted companies. These companies usually follow strong corporate governance models and show potential for high growth. However, their lower credit ratings present a riskier profile, particularly for conservative investors. SEBI guidelines restrict these funds from using the accumulated money for lending purposes.

3. Fund of Funds

   Fund of Funds diverge from direct investment strategies by investing in other AIFs. They don’t maintain their own investment portfolio; rather, they focus on diversifying across various AIFs, providing investors with broad exposure to alternative investments.

Category 3

1. Private Investment in Public Equity Fund (PIPE)

   PIPE Funds specialise in investing in publicly traded companies. They typically acquire shares at a discounted rate, offering an alternative route to investing in public equity with less administrative hassle.

2. Hedge Funds

   Hedge Funds pool resources from accredited investors and institutions to invest in a wide array of domestic and international markets. Known for their aggressive investment strategies, they aim to generate high returns. However, they are also noted for their higher management fees, often around 2% of assets, plus up to 20% of the generated returns as performance fees.

India’s alternative investment market has increasingly garnered the attention of institutional investors like pension funds, endowments, sovereign wealth funds, and insurance companies.

The draw?

The potential for higher returns and the benefits of diversification that alternative assets offer. Investing in Alternative Investment Funds (AIFs) offers a unique advantage to diversify the portfolio beyond traditional stocks and bonds. This diversification can significantly reduce risk as AIFs often operate in markets or sectors not closely correlated with standard markets.

Source

The past five years have been a period of tremendous growth for India’s AIF industry. The total AUM has increased almost threefold, from US$34 billion in FY 2019 to US$101 billion in FY 2023.

The AIF industry expanded by 30% in FY 2023 alone, reaching an AUM of US$101 billion, up from US$78 billion in FY 2022. Category II AIFs, which include real estate funds, private equity funds, and funds for distressed assets, have been particularly dominant. At the end of March 2023, commitments totalling US$84 billion were primarily made with Category II funds, marking a significant increase from the previous year.

AIFs are not open to all investors; they have specific eligibility criteria. They are primarily aimed at accredited investors, institutional investors, and others with a substantial investment capacity.
The minimum investment requirement for most individual investors is set at Rs. 1 crore and for accredited investors Rs. 25 lakhs, ensuring that participants have a significant financial stake. However, for insiders like directors, employees, and fund managers, the threshold is lower, at Rs. 25 lakh.

AIFs also come with a minimum commitment period of three years, which means investors should be prepared for a medium-term investment horizon. However, please note that the life of most funds can range from 7-10 years, with extensions. Moreover, the number of investors in each AIF scheme is capped at 1000. The exception to this rule is angel funds, where up to 49 investors are allowed. This limitation ensures a degree of exclusivity and a focused investment strategy for each fund.

Residents of India, Non-Resident Indians (NRIs), and foreign nationals are all eligible to invest in these funds, making AIFs a versatile option for a wide range of investors.