Hedge funds commitments dip 2.7% in first-ever drop in the category

Pandemic year has seen a slowdown for other kinds of alternative investment funds too

Wealthy investors’ commitments to invest in sophisticated funds which look to provide market-beating returns have declined for the first time on record.

The total commitments to category III alternative investment funds, which include hedge funds, dropped by Rs 1,326 crore in 2020. Total commitments fell from Rs 48,151.4 crore at the end of 2019, to Rs 46,824.9 crore at the end of December 2020, shows regulatory data which is released with a lag. This is the first time that commitments have seen a decline since records are available from 2012.

The Securities and Exchange Board of India had come out with regulations for alternative investment funds in 2012. It includes three categories. Category III allows funds to invest borrowed money to increase returns. This is the category under which domestic hedge funds register with the regulator.  Hedge funds often take positions which allows them to profit from markets going up or down. Category III also includes other funds which only look to make money when markets go up.  Category I funds invest in start-ups, social ventures as well as small and medium enterprises, among others. Private equity funds and schemes investing in distressed assets are among those that make up category II.   

Ashish Shanker, deputy managing director at Motilal Oswal Private Wealth Management said poor traction for equity schemes overall among the wealthy may have played a role in the slowdown. Also at play could be the fact that category III funds are subject to higher levies, which eats away at returns.

"For many clients, it becomes quite taxing," he said.

The government raised the maximum tax on individuals and trusts to 42.7 per cent in 2019. Unlike many schemes, category III alternative investments funds do not have a pass-through status. This means that they, and not their end-investor, pays the tax on any income over Rs 5 crore. This means that out of every Rs 100 made after this threshold, around 42.7 per cent will be paid as taxes. This may make it more tax-efficient for the wealthy to invest directly rather than come in through a fund, according to experts.

Investments in equity mutual funds have also been going down. They have dropped for seven months in a row as of January, Business Standard had reported earlier. Investors reportedly pulled out over Rs 42,000 crore from equity schemes since July as investors book profits amid all-time highs, and others chose to invest directly in the stock market.

The absence of new product launches during the pandemic year may have had an impact on new commitments, according to Anshu Kapoor, who heads Edelweiss Investment Management at Edelweiss Financial Services.

“The market environment was not conducive to launch new products,” he said.

He said that the scenario may well change in 2021.

Commitments have grown 27.1 per cent across all categories. This is the slowest since 2012. Category II funds have been the fastest growing among the three driving growth overall. It saw commitments rise 35.3 per cent over the previous year.  The category includes distressed funds which have gained in popularity in recent times. Category I schemes are up 9.1 per cent in commitments over the previous year.  

Alternative investment funds have a minimum investment of Rs 1 crore.