Alternative Investment Funds after Sebi order: Impact, rules explained

Such funds use complex trading strategies through investments in listed, unlisted stocks and derivatives.

Securities and Exchange Board of India, the country’s market regulator, has said any passive breach of concentration norm by Category-III Alternative Investment Funds (AIFs) will have to be rectified within 30 days of the breach. The move is expected to impact investments by hedge funds.

Here is what the funds are.

What are Cat-III AIFs?

Category-III AIFs are funds that use complex trading strategies through investments in listed, unlisted stocks and derivatives. Hedge funds and private investment in public equity (PIPE) funds fall under Cat-III AIF.

What are concentration norms?

Just like mutual funds, the investments made by Cat-III AIFs are capped at 10 per cent of the scheme corpus. In simple words, a hedge fund with assets under management (AUM) of Rs 1,000 crore can invest only up to Rs 100 crore in a single stock. The concentration norms are to ensure diversification and to prevent over-reliance on a single stock or a security.

Active versus passive breach

Active breach is when a fund manager deliberately exceeds the 10 per cent concentration limit. This can be done by actively taking more-than-permitted exposure to a stock. A passive breach on the other hand is inadvertent. For instance, if the fund’s holding in a stock is near the 10 per cent cap. Imagine, this stock outperforms, while other holdings in the portfolio see a drop. This will lead to passive breach of 10 per cent concentration norms. Sebi has allowed 30 days for funds to realign their holdings to below 10 per cent.

What are the AIF industry’s concerns?

Industry players feel that they will be forced to liquidate their holdings in stocks that have performed well. They say at the time of investment; they had compiled with the concentration norms. However, if due to market behavior the norms could be breached, they shouldn’t be forced to sell their holdings. Also, these could lead to tax-related complications.