Need to diversify? Create wealth by investing into Alternative Investment Funds

Sep 30, 2017 12:33 PM IST | Source:

In the process of evaluation of one’s financial goals, the requirement of liquidity at intervals and the ability to absorb the risk (drawdowns) in achieving the same is necessary.

It was a path-breaking evolution for investors and fund management industry when SEBI launched the very forward-looking Alternative Investment Funds guidelines in 2012. After five years of the guidelines coming into effect, the industry as of today stands close to Rs 96,000 crore across categories with the potential to grow multifold times.

Alternative Investment Funds industry or AIF is hugely developed globally, offering various investment strategies outside the ambit of traditional mutual funds and long-only products.

AIF’s have been successful in deepening the markets while providing much-needed capital in the economy.

As awareness about strategies offered under the AIF’s increased among investors leading to a place in their investment portfolios, it is extremely important for an investor to understand the measures of performance of the product to suit one’s portfolio.

Under AIF’s there are enormous possibilities to offer products and strategies across asset classes and risk-return matrix.

The study of performance parameters across risk and return, along with liquidity, while evaluating an AIF will help an investor to make a much better decision of choosing the right product and strategy.

While the past track record and experience of the team in managing the strategy is extremely important, various measures like volatility (standard deviation), drawdown’s, Sharpe ratios, correlation etc. help to objectively evaluate the strategy.

These are the variables which in past an investor wouldn’t have much cared about while investing in a traditional equity and debt product.

However, to achieve the target objective of the portfolio investment through AIF’s, a careful study and evaluation are pertinent.

In the current structure of AIF regulations, products essentially come under three well-defined categories.

Each category classification comes with distinct objective and constitution, in terms of instruments, asset classes, and structure.

Primarily Category I and Category II focuses on non-leveraged, unlisted instruments and asset classes, whereas Category III deals with leverageable listed securities across asset classes (currently equities, debt, and commodities).

In the process of evaluation of one’s financial goals, the requirement of liquidity at intervals and the ability to absorb the risk (drawdowns) in achieving the same is necessary.

Generally, Category I and II is likely to have a longer gestation, illiquid profile of investments with fund duration of more than 3 years.

It consists of popular strategies like Venture Capital / Private Equity / Real Estate / Credit funds to name a few, all having a different risk-return profile.

The intent of the funds is either to generate higher yield (primarily real estate and credit) or seek long-term capital appreciation (PE / VC Funds). In an investor’s portfolio, these strategies would attract a pool of money which is clearly not needed within a span of 3-5 years.

In terms of the factors to evaluate these funds, a great amount of weight is given to the team who has a credible track record of exits with consistent performance. Apart from the team’s softer aspects like third party service providers, valuers, lawyers and the offer documents are also extremely important.

Unlike public listed funds where prices are visible every day, the larger part of the evaluation of these funds essentially will be concentrated on the process aspect of investments.

Investors are advised to carefully evaluate the offer documents and cost structures to be sure of not having any potential negative surprises.

Category III funds are relatively easier to analyse, since the investments are listed and the pricing is not subject to any interpretation or a view. However, one important variable, which is a standout is the ability to leverage.

Category III funds have the ability to leverage and thus open a different perspective to risk. While the leverage piece can enhance the returns, equally if not being prudent can amplify the drawdowns as well.

Thus, understanding of strategy and risk profile is necessary beforehand with respect to larger benchmarks available like debt or equity.

Also, as mentioned above, important statistical parameters like Sharpe ratio (assesses the amount of risk taken to achieve the return over benchmark), drawdowns (negative returns), volatility (a measure of risk taken) etc. are used to profile or bucket your investments.

Popular strategies under Category III have largely been long-short equity funds. There are also different versions of it, from relatively lower to higher risk along the risk-return curve.

We have witnessed some long-only equity strategies as well, however, investors need to assess the differentiation with the long-only funds available under mutual funds and PMS’s.

On an overall AIF perspective, because of the differentiated strategies and active involvement of the fund management team, like globally, they have the ability to charge a performance fee. This is also in sync with the “alignment of interest” between the investors and fund manager.

In conclusion, AIF is a great vehicle, which has the ability to provide differentiated products along the risk-return curve. It can be a great tool for achieving the long-term financial goals as well as diversification of the portfolio of investments albeit with a careful assessment.

Disclaimer: The author is Co-CEO & Fund Manager, Avendus Capital Alternate Strategies. The views and investment tips expressed by the investment expert on are his own and not that of the website or its management. advises users to check with certified experts before taking any investment decisions.

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