The oak fought the wind and was broken, the willow bent when it must and survived. — American author Robert Jordan.
Jordan puts it creatively: when the times are tough, one needs to be flexible and adaptive. The volatility engulfing the world markets is putting the entire investing world in a tizzy. It seems that the alternative investment funds (AIF) industry is primed to handle the rough and tumble of the wild market swings with its diverse array of products, wider capital pool, greater flexibility in allocation and higher risk management.
AIFs, which started in 2012 after market regulator Sebi framed the AIF regulations, have grown 20% annually over the past decade. AIF Category I covers early-stage funding, and comprises venture capital, social ventures, small medium enterprises (SMEs). Category III which covers hedge funds accounts for 13% of the industry asset under management (AUM) and category II covering private equity accounts for 77%. The AUM for alternative investments is estimated to be $54 billion which accounts for less than 4% of India’s public market capitalization as of March 2020. The low AUM is mainly because of the fact that the minimum investment size for investors, at ₹1 crore, is high.
The rapid growth of AIFs was boosted by demand for private equity (PE) and debt. Investors are preferring AIFs as their listed equity portfolios are more focused or thematic and tend to be more benchmark-agnostic compared to mutual funds (MFs). The frenzied growth in PE was primarily driven by new age tech startups which are mostly unlisted and therefore only available through the AIF route.
Lower returns from fixed income instruments, and extremely stretched equity valuations have also contributed to the meteoric rise in PE investments. The spurt in liquidity as global central bankers took an accommodative monetary policy stance also helped the industry. Risk-on investors fished around for pre-IPO deals. To add to that, InvITs and REITs caught the fancy of investors as the debt market remained lukewarm. Also, lowering of the ticket size helped investors access newer products.
Venture capital funds also raised commitments of ₹34,569.56 crore during December 2021, a 29% jump from the same period last year. The AIF capital pool has widened, buoyed by M&A activity at home. Buyouts by Tatas ($1 billion Big Basket) and Reliance Industries ($200 million in Dunzo) aided PE/VCs exits. Also, listings by Zomato and Paytm in public markets have encouraged many start-ups to eye successful listing, raising the probability of easy exits by investors. Allocation to AIFs have increased due to base expansion of private debt markets’ investors in India.
These events have boosted the AIF industry sentiment. Also, new funds were raised and new managers came to the fore. The new managers prefer to set up an AIF and raise capital from domestic investors backed by their local networks. Also, wealth management firms raised pre-IPO and late-stage AIFs to the tune of $1 billion by catering to broader client base. New investors were attracted by short investment horizons and visibility of exit through public markets. Private debt allocation is driven by lower yields in listed AAA or quasi government debt papers. It has also been aided by MFs and non-banking financial companies’ inability to participate in a number of transactions due to changes in market dynamics and regulation after the IL&FS crisis. Comparatively, alternatives like real estate and gold have lost their sheen. Also, AIFs have reduced their gestation periods for the comfort of private market investors. Category III – long only equity or long short funds (hedge funds) offer diversification as they employ diverse, complex trading strategies and leverage through investment derivatives.
Separately, categorization of start-ups under the priority sector lending also boosted liquidity. AIFs have raised a total of ₹6.09 trillion, up 38% from a year earlier, according to December 2021 data compiled by Sebi.
Hedge funds are gaining traction and increasing fast in terms of AUM. These are being preferred as they have lower risk and are also yield alternative plays. Alternative yield options like InvIT and REITs provide steady cash flows at a time when fixed income returns are unattractive. Therefore, access to wider capital pool especially of global flows, the expansion of the private markets and greater investment flexibility is fuelling the rise of AIFs as the new MFs of India.
Alok Saigal is president and head—private wealth, Edelweiss Wealth Management.