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The Scope of Alternative Investment Over the next several years the country needs to invest a substantial $1.5 trillion in physical infrastructure to grow the economy and meet the aspirations of Indians

By William J. Kelly

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Investments in real estate, private equity, land, venture capital, intellectual property, and equity long-short strategies are all alternative investments. An investment not made in bonds, stocks, and cash may be considered an alternative investment.

Across India, there are three categories in which alternative investments may be made. Investments in SME Funds, Infrastructure Funds, Social Venture Funds, and Venture Capital Funds are classified under Category 1. Funds in Category 1 invest in economically and socially desirable ventures. Private Equity Funds and Debt Funds fall are classified under Category 2 Alternative Investment Funds. An alternative investment that doesn't fall in Category 1 or Category 3 may be clubbed in Category 2. In Category 3 are funds that employ complex and diverse investment strategies that take on higher levels of risk in an effort to earn higher than average returns. Funds in the third category may use leverage and invest across different investment products. Hedge Funds fall in Category 3. Today there are over 520 Alternate Investment Funds registered with SEBI.

SEBI's decision late last year to allow Alternate Investment Funds to operate from International Finance Services Centre (IFSC), Gift City is an effort to bring the AIF industry on shore from places like Mauritius and Singapore. The new platform for AIF's at IFSC allows private equity investors to launch funds at marginal cost. AIF's launched from IFSC will be dollar based making them convenient to Indians wanting to make offshore investments.

Investing in Infrastructure, Venture Capital, and SME Funds

India is developing rapidly and its leaders and people have global aspirations. The fulfilment of these global aspirations demands the construction of world-class infrastructure across the country. To the countries leaders not only are more and better roads, bridges, airports, railways, and ports essential to meet national aspirations, they are essential to fuel the economy. Over the next several years the country needs to invest a substantial $1.5 trillion in physical infrastructure to grow the economy and meet the aspirations of Indians. In this atmosphere, Infrastructure Funds are financing construction of infrastructure across India.

The Government of India established the National Investment and Infrastructure Fund Limited (NIIFL)in 2015 to invest in domestic infrastructure and take advantage of growth just over the horizon. In effect funds such as the NIIFL will align the interests of investors with the ambition of the nation.

Home to approximately 7,200 startups, India has a vibrant startup ecosystem in which investments can be made through Venture Capital Funds. A large number of Indian startups are creating efficiencies and bringing about lasting behavioural change in society. As Indians grow accustomed to using services of disruptive startups and their lives synchronise to the services of startups, risks of failure will remain high however some of these startup will likely create lifelong customers and earn attractive returns for investors. Much of urban India is undergoing a behavioural change fuelled by startups. From companies encouraging consumption of fresh foods to food delivery and ride-hailing apps, all are causing behavioural changes whose momentum is changing habits, preferences, and lifestyles. Venture Capital Funds capitalise on the growth trajectory of the Indian startup ecosystem and behavioural changes permeating Indian society. The venture capital space in India also has government backing in the form of frameworks that institutionalise it. Such institutionalisation gives investors clarity about the structure, process, and due diligence of investments in startups making investing in Venture Capital Funds attractive. The recent government decision to ease norms for startups including exemptions for AIFs investing in startups makes Venture Capital Funds even more attractive.

Medium-sized enterprises are heavily traded on Indian browsers. SME Funds have been established to take advantage of such trading. Because of the relatively high volatility of SMEs, investing in SME Funds is suited to less risk-averse investors.

Private Equity Funds Poised for Growth

Private Equity (PE) in India has come of age. An investment in private equity is likely to growmore today thanit did in earlier periods. The spectacularly high exits made in 2017 and 2018 highlight this. In 2017 Private Equity Funds received investments in excess of $26 billion while exits from investments stood at $16billion.

Globally private equity manages nearly $3 trillion. India's share in global private equity is minuscule and private equity in India attracts investorsbecause of the economy's growth trajectory and growing wealth of investors. Private Equity Funds aren't investment vehicles for unsophisticated investors. Only a fraction of Indian investors, less than .01%, can invest in private equity because such investments demand significant capital and financial astuteness.

The risk appetite and sophistication ofmany wealthy Indians cannot be accommodated by the stock market. Such Indians, hungry for higher returns, take the private equity route. In 2018 the scope of private equity was plainly seen when PE exits, helped by Walmart's purchase of Flipkart, topped $25 billion. Global institutional investors are already attracted to private equity in India because of recently introduced structural reforms including the Goods and Services Tax and Bankruptcy Code.As the Indian economy grows, individual wealth grows, andexpertise of Indian firm's blossom,more investors may gravitate to investing in PE Funds.

Hedge Funds at a Nascent Stage

Hedge Funds are a new investment vehicle in India but suffer because of an unfavourable income tax regime that taxes hedge funds gains at the fund level. The income tax laws in India have failed to define hedge funds. After Private Equity Funds, Venture Capital Funds, and Real Estate Funds, Hedge Funds are the most popular AIF in India. Because some hedge funds are expected to generate returns in rising and falling markets or provide risk premia that is uncorrelated to the public equity markets, Indian investors with higher risk appetites are attracted to them. While not the most popular AIF, the promise of returns in falling and rising markets or lower overall portfolio volatility through diversification make them attractive to Indian investors. A more favourable tax regime governing hedge funds is likely to increase their attractiveness.

Investing in stocks is widespread across India and millions of retail investors have capital invested in Indian browsers. To some wealthier, astute investors, AIFs may be ideal instruments. Certainly, one of the most important reasons to invest in AIFs is the low correlation of different classes of AIFs with other investment vehicles and each other; this presents significant opportunities to hedge. As the AIF ecosystem in India grows from among the smaller in the world to one of greater global prominence, its goal of presenting sophisticated investor's opportunities to protect or grow wealth beyond that possible through traditional investments may be realised.

Patience and informed consent are the hallmarks of what usually defines success for most things in life, and investing is certainly not an exception to that rule. Due diligence and education are extremely important, and every investor, either on their own or through the services of a trusted advisor, should not approach any investment without understanding the alignment of their expectations relative to the underlying risks that they are taking on. Diversification across uncorrelated asset classes is not a straight-forward exercise, as performance dispersion gets very wide in many alternative offerings. Target allocations to the broad buckets of hedge funds, private equity and venture capital absent thorough due diligence is likely going to disappoint most investors. Finally, a long-term view for your investment plan is essential. The most successful investors are the ones who keep an eye on the distant horizon by remaining fully invested across a diverse set of risk premia, paying less attention to the interim and inevitable sharp edges of volatility.

William J. Kelly

CEO of The Chartered Alternative Investment Analyst Association (CAIA Association)


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