Category-III AIFs increasingly forego lock-ins, turn to open-ended schemes

Majority of funds now open for subscription have no lock-in

Sophisticated investment funds for the rich are increasingly foregoing mandatory lock-ins amid a drop in inflows.

These category-III alternative investment funds (AIFs) increasingly allow investors to withdraw their money at will even as clients express preference for higher liquidity amid the uncertainties caused by Covid-19. Each fund has a minimum investment of at least one crore rupees. Around 20 out of the 28 category III AIFs which have subscriptions open for investors currently, for which data is available, fall in the open-ended category, shows an analysis of data from industry tracker PMS Bazaar.

The trend is only gaining momentum, according to PMS Bazaar founder-director Daniel GM. There have already been a number of funds which are already open-ended by design. Some professionals who had launched closed-ended funds are also now turning to the open-ended format. More are likely to be on the way according to him.

“I find that a lot of open-ended funds will emerge in the future,” he said.

Some of this may have to do with the emergence of liquidity preferences during the Covid-19 pandemic according to Nikhil Kamath, co-founder and chief investment officer at asset management firm True Beacon which runs a category III AIF. Investors now prefer to have cash that they can quickly lay their hands on if the need arises. Some may have capital which they would normally deploy in their business. Lower activity levels may prod them to invest in a fund which can provide returns to their idle capital without locking it in, according to him.

“They prefer open-ended because they can take the money out when they want,” he said.

Category-III AIFs include hedge funds which invest in public markets. They can take bets on market direction. This means they can also make money when markets are crashing. They are characterised by the fact that they can also invest borrowed money to provide higher returns. Category II AIFs largely include private equity funds which invest in companies of a certain maturity. The regulatory also classifies funds investing in distressed assets as Category II AIFs. The category is not allowed to use borrowed money in addition to investor capital. Category I AIFs invest in start-ups as well as small and medium enterprises. They also include social venture funds and infrastructure funds. Category I and Category II AIFs typically make illiquid investments. This means that they can’t sell their stake in the underlying company very easily unlike category III AIFs which have exposure to listed companies whose shares can be more easily bought and sold on the stock exchange.

This has also meant that the first two categories of funds haven’t seen a similar trend towards open-ended schemes because of the nature of their underlying investments. All ten funds from the first two categories which are currently taking investor money according to PMS Bazaar data, are closed-ended.

The change towards open-ended category III AIFs also comes at a time when investors have been allocating less money to them. Higher taxation is said to have made the category less attractive to investors. Category III AIF fund-raising grew only 2.2 per cent in 2020, compared to nearly 20 per cent in the previous calendar year.