Understanding alternative investment funds in Europe

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India is one of the fastest-growing global economies and has a vibrant commercial culture. But along with growth comes inflation, for every emerging market, levels of which can be contained but not avoided. Safety, capital gain, and steady returns are some of the top goals for any Indian investor. The question arises – are your returns “real”?

It is important to understand the difference between nominal returns and real returns.

Nominal returns are a percent that is offered by your banker, investment company or the market, in your own currency. Real returns on the other hand are the “real” value of your returns after factoring in factors such as inflation and currency depreciation.

Imagine, you have deposited Rs 1,000 today with your banker and your banker offers you an interest rate of 6 percent. You get back Rs 1060 one year from now. Simultaneously, imagine that the price per kg of basic consumable is Rs 50 today. If the same consumable were more than Rs 53.5 per kg in a year from now, your interest rate is 0 percent. In this example, your banker offered a 6 percent nominal interest rate while your real interest rate was 0 percent or negative. As another example, let us look at Venezuela where Bank Deposit rates are over 55 percent. But, with inflation over 400 percent, would it make any sense to invest?

(Graph Source: https://www.macrotrends.net/countries/IND/india/inflation-rate-cpi

Data Source: https://datatopics.worldbank.org/world-development-indicators)

The economic volatility in the current environment has created concerns in the minds of Indian investors who are unable to envisage the real ROE (return on equity) from their investments. Considering the recently announced ~7 percent inflation and ~6 percent bank deposit rates, Indian depositors are likely to be left with negative real returns on their rupee deposits, just like their western counterparts whose banks offer negative or near zero interest rates on $, € or £ deposits. Likewise, investing in rupee equity funds that yield 10 – 12 percent IRR (internal rate of return) is also likely to result in real returns of under 5 percent once inflation and rupee depreciation are factored in.

Since, negative or near-zero interest rates in the West have been commonplace for many years now, investors have moved on from bank deposits to investing in listed securities, REITs, and unlisted AIFs to spread their risk-return profile.

A key sector for investment in India is Real Estate. Over the past decade, best performing cities included Lucknow with an IRR of 16.1 percent per year. Kolkata at 13.3 percent, Delhi at 12.2 percent and Mumbai at 11.2 percent. Jaipur was at the bottom with an IRR of 6.1 percent per year. For homeowners, this is would still be a matter of concern when they compare the “value” – what Rs 100 could buy in 2010 v/s what the same Rs 100 can buy today?

However, the situation is quite different in case of foreign investors who are able to negotiate IRRs in high-teens to early-20s with Indian borrowers and prominent real estate developers, factoring in their hedging cost against rupee depreciation which is directly correlated to inflation. These deals are not available to retail Indian investors as their ticket size is smaller which then requires them to invest via mutual funds or AIFs in India, who in turn compete with foreign investors by usually offering lower IRR thresholds.

All of the above combined, creates an atmosphere where your money is devaluing faster than you think. Low-interest rates coupled with rising inflation is causing investors to look for substitutes in India and abroad. Some have started investing in start-ups while others have started betting on Fx derivatives. Diversifying a part of your investment portfolio to € or $ denominated opportunities is one of the several practical and sustainable ways of preserving your wealth and earning “real” passive income.

What are Alternate Investment Funds (AIFs)?

AIFs are regulated investment vehicles designed to finance opportunities in real estate, venture capital, infrastructure, and many other industries. Real Estate AIFs are most popular because of the underlying asset being a physical asset itself which provides baseline comfort to investors.

Like mutual funds, AIFs could be equity, mezzanine or debt strategies and have the potential to produce higher economic returns because of off-market opportunities otherwise unavailable to general investors.

The success of AIFs across the board proves that resilient investors can make their money work for them. Long-term investors are increasingly considering overseas funds to hedge their local investments. This non-traditional investment is now becoming mainstream for investors to participate in asset classes that they would otherwise not have access to.

Unlike mutual funds which is a preferred investment vehicle for Indian investors of all ticket sizes, AIFs are more suitable for well informed and professional investors. One must intimately understand the fund specifications before choosing where to invest. Risk-return analysis is a good place to start shortlisting potential investments.

How can Indian’s benefit from investing in European AIFs?

Real estate IRRs around European Markets (like India) are in the low-to-mid teens, but they are denominated in € (Euros). It is a remarkably simple situation where 10 percent on € denominated investment will “really return” more value than 10 percent in ₹ denominated return.

Thus, Indian investors, a majority being non-resident or resident HNW, are now increasingly diversifying a part of their investments in € and $ denominated instruments. The RBI’s LRS (liberalised Remittance Scheme) allows investors to invest upto $250,000 each year abroad without any prior approval from the central bank.

As Europe becomes a keen trading partner for Indian businesses and a superior choice for immigration, investing in their markets has become a natural progression. Europe has a free market economy with transparent investment policies, strong regulatory framework, and attractive real returns. Despite the global upheaval in 2020, the real estate market has remained steady in the most EU countries fuelled by liquidity injection by the central bank, generating either minimal damage or sustained returns for investors worldwide.

Some European AIFs come with benefits more than just real returns on your money. These investments can also qualify your family’s residence rights in the investee country via the so-called Golden Visa programs. Countries like Portugal, Greece, and Cyprus welcome investors via several such programs which allow the investor and their family to acquire their residency and eventually, a European passport, should they like. Other advantages include tax breaks, arbitrage gains on repatriation, access to education, healthcare, etc. that are making investing in Europe for Indian investors more lucrative than ever before.

The author, Ashish Saraff, is Founder and CEO at Aretha Capital Partners. The views expressed are personal

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