Sebi's new asset class proposal: How far can it quench risk-taker's thirst?

Currently, there is no structured product available to those who have a negative outlook. This drives them to derivatives, where only one out of 10 investors makes profits

Mumbai-based Mayank Mehta has been investing in mutual funds (MFs) sporadically over the past 10 years. Though he often signs monthly cheques for systematic investment plans (SIPs), he is more inclined towards derivatives. “Most of my MF investments have yielded good returns, but I am more drawn to derivatives trading. It gives the adrenaline rush that the slow-grinding MF investments don’t,” says the 30-year-old software engineer. 

Mehta concedes that derivatives are not easy to crack and one can often end up on the losing side. He also takes cues from random messages on social media, but cautions that “sometimes they work, often they don’t.” 
 

Mehta feels the sweet spot would be to have an expert or fund manager invest his money in derivatives. To be sure, there are portfolio management services (PMS) and alternative investment funds (AIFs) that take riskier bets. However, their minimum ticket sizes are Rs 50 lakh for PMS and Rs 1 crore for AIFs. 

 

Those like Mehta, who want to invest a few lakh rupees in derivatives have to either resort to the do-it-yourself technique or settle for MFs, which are allowed to use the derivatives segment only for hedging. Mehta is yet to fall in the trap of schemes that promise unrealistically high returns, but several others have. 
 

To address this problem, the Securities and Exchange Board of India (Sebi), the markets regulator, has proposed a new asset class that will sit in between MFs and PMS or AIFs. The minimum ticket size for the yet-to-be-named asset class is proposed to be Rs 10 lakh.

The regulator has said the structure of the proposed asset class will be akin to MFs, but it will be allowed to offer riskier investment strategies. The various investment thresholds in debt securities or real estate investment trusts (REITs) and infrastructure investment trusts (InvITs) will be slightly more relaxed vis-à-vis MFs.
 

If the proposal is accepted, the Indian markets will see the launch of structured investment products that will be within the reach of many investors. 

 

Long and short of it
 

Some such strategies will be the globally popular ‘long-short equity fund” — which seeks to deliver superior returns by taking both long and short positions in equities depending on the outlook — or an inverse exchange traded fund or bear funds, a fund that generates positive returns when the market falls.
 

Currently, if you have a negative outlook on the overall markets, or a sector, or a stock, there is no structured product available for investment. As a result, investors get drawn to the derivatives market, where only one out of 10 investors is able to generate profits and where retail losses exceed Rs 50,000 crore in a financial year.

On the product side, the new asset class will help plug a gap not just in the equity space but also in the 

debt space.
 

“There is a gap in the structure of debt products in MF space, where the daily liquidity provision has made it difficult to manage credit or accrual propositions. This is because the rush of investors exiting the fund in case of possibility of a credit event poses a liquidity challenge and results in propositions for existing investors becoming unattractive on risk-reward propositions for no fault of theirs and all this even before the event happens. A healthy capital market requires development of both equity and debt markets,” said Akhil Chaturvedi, Executive Director, Motilal Oswal AMC.

 

Tax structure the key
 

MFs enjoy an edge over PMS products. Their portfolio churn does not attract short- or long-term capital gains tax (STCG or LTCG). It remains to be seen whether the new asset class will enjoy an MF-like structure, which will be a key to its appeal.

As the new asset class’s broad operational and legal framework will be borrowed from MFs, experts believe it may also get the LTCG and STCG pass-through status at the fund. This will give them an edge as Category 3 AIFs do not have similar status. In the case of PMS, the investor has to pay the taxes on the capital gains whenever the fund manager makes a profitable trade.
 

“The biggest use case will be tax. This structure, being part of the mutual fund umbrella, gets the benefit of no taxation at a vehicle level. On the other hand, PMS is a pass-through, while Cat 3 AIF needs to pay tax at the level of the trust,” said Somnath Mukherjee, CIO and Senior Managing Partner, ASK Private Wealth.
 

PMS and AIF providers believe the introduction of NAC will put the spotlight on levelling the playing field when it comes to tax structures, or they could route their investments through the new structure.
 

“I strongly feel PMS and AIF should be given the option to participate in this new asset class. They are suited to handle HNI money,” said Manish Bhandari, CEO and Portfolio Manager of PMS firm Vallum Capital Advisors and a board member of the Association of Portfolio Managers in India.

 

Distribution model
 

Though the proposed new asset class has got the market excited, some believe it may not offer something which is not already available.
 

According to Mukherjee, the new asset class is unlikely to offer a new use case and will only compete with PMS and AIF. Soumya Sarkar, co-founder of MF distribution firm Wealth Redefine, said that though the new asset class may have its own advantages, adoption might take off only after investors get a hang of the new offering.
 

Given the rising share of non-financial assets in domestic households, more investment avenues will be welcome and there will be space for each vehicle, as it will cater to a different class of investors.
 

The key area the Sebi consultation paper does not delve into is the revenue structure for the manufacturers. This is also the area, say experts, that can weaken the new asset class as a concept. Some in the MF industry believe the structure will mostly be similar to that of MFs, wherein expenses are charged at the fund level based on its size. In comparison, PMS regulations also allow firms to charge a performance fee.
 

MF players say that though a performance fee is a good idea, it is not easy to implement in a pooled investment product, especially the open-ended ones. Sebi had mooted the idea of performance fee in MFs early last year, but it did not materialise.