HNIs curb flows to long-short AIFs as higher taxation pinches

Sebi data shows that commitments raised by category-III AIFs in September quarter were down 10% QoQ

Alternative investment funds (AIFs), especially those that deploy long and short strategies, are feeling the pinch of higher taxation as commitment to such products from high networth investors (HNIs) is reducing.  

Data sourced from the Securities and Exchange Board of India (Sebi) showed that commitments raised by category-III AIFs in the September quarter had reduced by 10 per cent quarter-on-quarter to Rs 42,223 crore. This was the first quarter of reduction in commitment since December 2012.

“The higher component of taxation for long-short funds has made such products less compelling for clients. Spreads compared to traditional fixed-income products have dipped on account of higher incidence of tax,” said Gaurav Awasthi, senior partner at IIFL Wealth.

Besides lower commitments raised, investments in category-III AIFs were also down 6.7 per cent, and fundraising declined over 7 per cent.

"There have been investor redemptions in products that offered debt-plus returns," said an industry official. "Further, the new money coming in has slowed down due to the current market conditions," he added.

In July, the Union Budget introduced higher taxation for trusts and associations of persons. This brought most of the category-III AIFs within the higher tax net, given that these are structured as trusts. Long-short funds comprise 65-70 per cent of the funds in the AIF-III category.

These take long positions on stocks, where they expect to see an upmove, and short positions where stock prices are expected to decline. Following the Budget announcement, funds — in which income earned is above Rs 5 crore — saw an effective tax rate of 42.7 per cent, up from the earlier 35.9 per cent.

This 6.8 percentage point rise in the tax rate could significantly weigh on net returns of sophisticated investors, who opt for structured products such as AIFs for slightly superior risk-adjusted returns. Recently, Sebi proposed a set of new norms in a bid to firm up disclosure and performance reporting standards followed by AIFs, keeping investor interests in mind.

Experts say while such measures are positive for investors, the rolling back of the higher taxation rate will ensure investor interest remains intact in long-short AIF products.

Over the last two financial years, the total investments made by AIFs have grown at a compound annual growth rate of 75 per cent.

In its consultation paper on AIFs, Sebi has proposed the setting up of a benchmarking agency to show comparable returns of various AIFs and standardising the private placement memorandum (or offering document), which informs investors about various aspects of an AIF such as fees, conditions or limits on redemption, investment strategy, conflict of interest, and manner of winding up of the AIF.