The rise of 'sophisticated' investors

Before the pandemic, the riches were busy catching up over coffee and dropping names of the new startup they have invested in. Almost everyone believed that they had invested in a multi-bagger, but then came the pandemic, and the hoity angels’ crowd progressed to become sophisticated investors, or so the Securities and Exchange Board of India (Sebi) defines investors who invest in alternative investment funds (AIF).

As per Sebi data, as on December 30, 2021, fund managers who run AIFs raised a total of ₹609,091.7 crore across categories—a 38 percent jump from what they had raised the year before. In December 2020, the figure was ₹441,994.73 crore.

The minimum investment limit to invest in an AIF is ₹1 crore, as Sebi wants sophisticated investors who understand the underlying risk of such kind of investments.
 
“The rise in AIF allocation is mainly driven by clients wanting to participate in private markets through both private equity (PE) and private debt. Most clients are also investing in AIFs, which invest primarily in listed equities as these are more focussed or thematic, and are more benchmark-agnostic as compared to mutual funds.

Allocation to PE has been driven by client eagerness to participate in the new-age disruptive tech companies. Most of these companies are unlisted and only available through the AIF route,” says Sahil Kapoor, senior executive vice president at IIFL Wealth. IIFL Wealth distributes more than ₹27,000 crore of AIFs on the platform, including listed equity, unlisted equity, real estate and structured credit.

One reason why capital allocation has moved towards such assets is due to lower returns on fixed income products. Another reason is that equity valuations are stretched—in fact, they are close to historic high levels due to the unleashing of liquidity by major central bankers across the world.

While the entire AIF as an asset class has witnessed more capital rushing in, the one that stands out is the category of Venture Capital Funds (VCF). Indian VCF fund managers managed to raise commitments of ₹34,569.56 crore during December 2021 compared to ₹26,791.7 crore during the same period last year, an increase of 29 percent.

Fund managers have come a long way this past decade, and now India has a wide range of managers with track records and a wealth of experience. At the same time, newer managers have emerged, breaking away from global shops like Sequoia and Warburg Pincus; they are launching their own franchises. Typically, the new managers prefer to set up an AIF and raise capital from domestic investors, where their personal networks are stronger.  

While the quality of managers is improving, a few firms without a strong history of private investing have also capitalised on the momentum of private companies going for an IPO by launching ‘late-stage’ or pre-IPO funds. When these funds were launched by wealth management firms, which raise funds for AIFs on a day-to-day basis, they had an inherent advantage in taking these opportunities to a broader client base. These structures appealed to the first-time private market investor because they offered a path to liquidity with a short hold like five years and through public markets.

IIFL Wealth’s Kapoor is upbeat on private debt strategies, which focus on performing credit, but avoid turnaround or distress debt. “We are investing across classic growth companies with high return on investment and cash flows and new age disruptive tech companies, which are market leaders in their niche,” he says.

Although real estate has been a laggard over the last five to six years, Kapoor sees the sector turning around and offering interesting opportunities on the back of consolidation, and early signs of revival in housing and commercial demand are visible. “Allocation to private markets (debt and equity) is typically capped in clients’ portfolios—10 percent to 20 percent. Although this asset class offers higher returns, it comes along with higher risk and very low liquidity. These strategies have long gestation periods too, so clients should be mindful before allocating to these strategies,” he says.

Another popular category is Cat III—long only equity or long short (hedge funds) that employ diverse or complex trading strategies and may employ leverage, including through investment derivatives. Total allocation to CAT III is nearly ₹57,000 crore as of December 2021.

According to data from a recent industry report, 50 percent of the total CAT III allocation is into Long Only Equity Funds. Absolute return funds and Long Short equity funds are nearly 12.5 percent each. The Long Short funds, which are also referred as hedge funds globally, are gaining traction and increasing fast in terms of asset under management. Long Short funds are gaining popularity considering the lower risk equity allocation strategy they offer.

“Most of the growth that we have seen in ITI Long Short Equity Fund is in current FY22. We were nearly ₹250 crore at start of April 2021. We believe the growth is because of two reasons. The first is that we were able to build a good track record of the fund’s performance by showing asymmetric return profile, while generating equity type returns with much lower risk. Also, confidence was built among investors as we were able to protect the downside during the market fall due to Covid in February and March 2020,” says Ajay Vaswani, senior vice president & business head-Alternate Investment Funds, The Investment Trust of India (ITI). Under CAT III, ITI has over ₹700 crore.

Within listed equities, the current inflationary environment and potentially rising interest rates augur well for the BFSI sector, industrials, building materials and select commodities. On the other hand, experts expect that companies with high valuations are likely to see their valuations come under pressure with interest rates rising.

In addition to traditional debt mutual funds, investors may want to evaluate certain yield-alternative avenues such as InvITs and REITs (or even some real estate debt funds) that tend to provide steady cash flows at a time when fixed income returns are unattractive. Long-short equity funds may also be considered as yield-alternatives that can comprise part of the listed equity allocation.