With the capital markets regulator, Securities and Exchange Board of India (Sebi), releasing its final guidelines on alternative investment funds (AIF), there is a reason for high networth investors (HNIs) to feel a little more confident when investing in riskier private funds.
As an HNI you may search for unique investment opportunities through structures, hedge funds or specific private equity (PE) funds. The new regulations mean that you can take that extra risk knowing that there is a framework that guides the manager and a precise set of regulations that govern their investment decisions.
However, remember that these guidelines only refer to funds where investors money is pooled: so money managed under portfolio management services (PMS) for listed equity doesn’t fall under this regulation.
Here’s what the new regulations mean for you.
What are AIFs?
AIFs are private investment funds that pool assets from a group of investors and have a defined target for that pool. Sebi’s intention (as stated in the concept paper) is to accurately regulate non-retail investment funds. Such funds come with diverse features and unique risks that need to be clearly distinguished before you commit money.
There are three distinct categories under AIF. Category I includes specific sector investments and focuses on the unlisted category of enterprises, where there is need for private funding. Similarly, category II focuses on unlisted enterprises but doesn’t limit the fund to a defined sector. This is akin to many sector-agnostic PE funds that are likely to fall in this category. The last category caters to any other kind of fund—hence, a fund that invests primarily in listed equity will qualify for this category. The last category also includes hedge funds that take leverage as part of their strategy and use a mix of assets and derivatives to achieve returns.
Hitherto, most such funds were registered under the Sebi Venture Capital Fund (VCF) regulations, which was not considered appropriate for the variety of funds available now, or they remained unregistered. Recognising this, Sebi proposed a separate section called alternative investment funds and last year floated a concept paper on guidelines for registering and operating such funds.
How would new guidelines help?
Know the fund objective: Thanks to the new categorization, you will know the fund’s objective at the beginning itself. So for you, there is no confusion on the kind of businesses or securities the fund seeks to invest in—and that can’t change materially over the course of time.
You will know beforehand the exposure in terms of sectors, listed/unlisted equity. Says Anshu Kapoor, head (global wealth management), Edelweiss Financial Services Ltd, “Now the industry has a regulated pooling vehicle that can offer liquid and illiquid investment options to HNIs. It makes sense as categories are defined and under a regulated structure.”
Closed-end funds make for long-term investing: Restrictions such as making funds closed-end and not allowing borrowing in category I and II funds means that the risk levels are more defined at the regulatory stage itself.
Higher minimum investment threshold: You have to invest a minimum of Rs 1 crore in a fund, so it is clearly accessible only to a limited set of people, who have surplus commensurate to the implied risk. Kapoor says, “Certain degree of sophistication and understanding is assumed for clients with such large surplus. Also, the commitment required from the manager to invest in the fund reduces the risk of mis-selling.”
Disclosure: Sebi has also guided on transparency in operations and sharing information through disclosure norms on various operational risk management issues, portfolio details and investee company financials, among other things.
While this new set of guidelines comprehensively address a number of matters linked to private investment funds—as is the case with many new guidelines—there are grey areas that need further clarification. Here are some.
Investment threshold and money to be raised for second closing: PE funds and the likes usually get permission to raise a large amount and they do that via more than a single issue or placement for the same fund. Now, Sebi has said that the new guidelines will apply immediately and existing funds falling under the AIF definition have six months to get registered under the new regulation.
Existing funds are restricted from raising fresh money under their old avatar, but what happens if the fund has only closed a first issue for the entire amount it is permitted to raise and a second issue for the leftover amount is open and waiting to be closed? Says Anish Sanghvi, associate director, PwC India, “If there is a second closing left for a fund registered as venture capital fund under the erstwhile Sebi (VCF) guidelines, it can raise fresh capital, provided the target size/corpus of the fund remains unchanged.”
Keep in mind though, under earlier guidelines there were funds that were not required to be registered. Says Naresh Makhijani, partner, KPMG India, “Schemes of the unregistered PE fund shall be allowed to complete their agreed tenor and such funds shall not raise any fresh money other than commitments already made.”
Moreover, for the purpose of such a second closing what is the minimum amount per client—Rs 1 crore as per the new regulation or Rs 5 lakh as per the older regime? Sanghvi feels this is a grey area and in case of a second closing, minimum investment thresholds for investors should be as per earlier guidelines.
What qualifies as a start-up? In case of venture capital funds, what qualifies as a start-up was not defined in the earlier VCF regulations and is not defined in the new guideline either. Says Makhijani, “Start-up has not been defined in the regulations. There could be diverse interpretation for this term.” Managers may use their own definition or understanding for a start-up. Says Sanghvi, “Among other things, the general PE community considers start-ups as entities that have innovative business ideas, though the business may be at a very nascent stage and in some cases, may not have taken off yet.”
Debt funds in category II: Another area of confusion is in category II which include debt funds—these are defined to mean funds that invest primarily in debt or debt securities of listed or unlisted investee companies. However, regulation 17(a) states that category II AIF shall invest primarily in unlisted investee companies. Makhijani points out that there seems to be some disconnect here.
Mint Money take
Kapoor suggests that with this framework in place there is room for innovation in sophisticated domestic products through the pooled vehicle, which were earlier available mostly to offshore funds. Other than providing a much needed framework, the new guidelines help investors be aware of what they are getting into and define a specific conflict resolution platform.
Even if you are an HNI with surplus money, you may not have the risk appetite for the entire basket which is really quite varied. So knowing the structure of your fund in advance is important and it is also important to know that the structure is being watched and regulated.
Also See | New Structure (PDF)
PDF by Paras Jain/Mint