Mutual funds' alternative investment funds push shifts into high gear

Flexibility, easier norms make AIFs an attractive option for wealthy investors

Mutual funds are upping the ante in the alternative investment funds (AIF) space with an aim to diversify their offerings and tap a niche client pool.

HDFC Mutual Fund (MF) has signalled its intent to get into the AIF space in its draft offer filed with the regulator last month. Axis MF plans several AIFs in the structured debt, equity and commercial real estate space. Franklin Templeton Investments is putting its team together for its AIF foray, while Mirae Asset MF is awaiting regulatory approval for its maiden real estate fund.

IIFL Asset Management has identified an opportunity in the affordable housing space and is in the process of launching a private equity fund. It already has IIFL Real Estate Fund, IIFL Special Opportunities Fund and Seed Venture Fund in its portfolio.

Reliance Nippon Life Asset Management subsidiary Reliance AIF has funds in the real estate, credit and equity space, and is looking at launching 3-4 more schemes across asset classes in the coming months.

Several MFs already offer portfolio management services (PMS) to clients and cater to global clients through their offshore advisory piece. AIFs are a natural extension of these offerings as funds have inherent fund management capabilities and can leverage their existing distribution network for selling these products.

"As the market matures there will a need for savvy products that allow for greater innovation and flexibility in terms of charges and distributor payouts,” said Sundeep Sikka, executive director & CEO, Reliance Nippon Life Asset Management.

AIFs are privately-pooled investment funds. Category-I funds invest in start-ups, small and medium-sized enterprises (SMEs) and venture capital. Category-II funds include private equity funds and debt funds, while category-III includes hedge funds.

Unlike MFs, AIFs can invest in the unlisted space and deploy long-short strategies, with no compulsion to hedge portfolios. They can play concentrated bets and make private investment in public companies. Category-III AIFs is a natural choice for MFs as it involves investing in listed securities, debt and fixed market products, said experts. Funds are also tapping the category II route that includes pre-IPO funds, structured credit and real estate funds.

“The ability to tailor schemes to market conditions, invest in unlisted equity and real estate, as well as commodities, makes AIFs a sought-after platform,” said Prashasta Seth, CEO, IIFL Asset Management.

An AIF structure allows for greater investment flexibility than PMS as well.

"A PMS structure does not allow pooling, does not accord a QIB (qualified institutional buyer) status for the purpose of IPO and qualified institutional placement allocations, does not allow leverage, and cannot impose a hard lock-in on investors,” said Tejesh Chitlangi, senior partner at IC Universal Legal. “All these things are possible with category-III AIFs."

“AIFs are riskier than regular MF schemes and require more research. Bigger fund houses have an advantage here as they have bigger teams and larger research capabilities,” added a senior fund official.

With the emergence of passive products and the increase in efficiency of the Indian market, generating alpha will become difficult for fund managers in the coming years, reckon experts. This is where AIF strategies will gain currency.

“There’s only so much upside that you can get from investing into 40-60 stocks through a typical MF scheme. An AIF can offer the potential of higher upside to those willing to take higher risks,” said Swarup Mohanty, CEO, Mirae Asset Global Investments (India).

As the pie grows, AIFs can help asset management companies shore up margins, as they can charge higher fees than MFs and PMS.

Expenses charged by MFs are capped as per a slab-wise formula laid out by the regulator. For instance, equity schemes can charge a maximum of 2.5 per cent for the first Rs 1 billion of assets. AIFs do not have such caps.  

Unlike AIFs, MFs face restrictions on commissions that can be paid out to distributors, with upfront commissions capped at 100 bps.

Sebi data showed investment commitments of AIFs reached Rs 1.41 trillion as of December 2017, a four-fold jump from Rs 307 billion two years ago.