Photo: iStock
Photo: iStock

Listed equity AIFs: new flavour, or a me-too?

The structure has some advantages but the strategy must be different to warrant the 'alternative' tag

With equity markets scaling all time highs, listed equity stocks are attracting an increasing number of investors. The latest managed equity portfolio product in the market are the long-only listed equity  Category III Alternative Investment Funds (AIFs). AIFs are managed funds regulated by the Securities and Exchange Board of India (Sebi) and Category III AIF is the only one that can invest in listed securities, including equity. Unlike equity mutual funds and portfolio management services (PMS), it requires a significantly higher minimum investment of Rs1 crore, making it suitable only for high networth investors (HNIs). Also, AIFs can use leverage, or they can borrow to invest, which the other two products can't. 

Long-only refers to a strategy of  buying and holding equity stocks, with no other alternative strategy involved. Long-only listed equity AIFs account for roughly Rs6,500 crore or 53% of the total Rs12,300 crore in funds raised under the Category III AIFs, as on 30 June 2017. Till June 2016, funds raised in Category III AIFs were about Rs4,800 crore. Why are these funds picking up?  

Adding to choice

Such funds are usually based on sharply defined themes and strategies. Recently, Emkay Global Financial Services Ltd. launched a 5-year closed end AIF, which will invest in small- and mid-cap stocks of market capitalisation between Rs300 crore and Rs1,000 crore, across sectors. The focus will be on identifying companies with scalable businesses and a focus on profitability and positive operating cash flows. 

Incidentally, Sachin Shah, this AIF's fund manager, also manages a PMS strategy that invests in small- and mid-cap stocks. Then why a similar AIF?

 “The market cap range for the PMS mid-cap product is Rs250 crore to Rs600 crore, so the stock selection will differ, as will the risk-return outcome. An AIF is a different vehicle. It operates in a Trust structure with a custodian. Taxation is at a Trust level; in a PMS, capital gains tax is applied at an individual investor’s level," said Shah. They aim to collect around Rs300 crore in assets under management, he added. 

It is logistically simpler to start investing via an AIF than a PMS; the investment is done in a fund with no need to open separate demat, trading and bank accounts. AIFs, however, don’t offer customised portfolios.  

The AIF structure is closer to a mutual fund, which also operates under Trust but MFs typically have much larger corpus. A small sized fund allows AIF managers to invest a higher proportion in stocks that have low free-float market cap and the overall stock portfolio can be restricted to a few high-conviction choices. 

A small corpus size and fewer investors means the AIF’s strategy and mandate can be made distinct, focussed on a particular theme. But, that one strategy must fit all participating investors, making it less flexible than a PMS. Its structure is like that of a mutual fund and the thematic focus is more akin to a PMS. 

More than just packaging?

A simple diversified, sector-agnostic AIF is unlikely to add more value than its mutual fund or PMS counterpart. But its structure can help where the other two leave a gap. 

“There is nothing ‘alternative’ about long-only listed equity AIFs. Showcasing newer products increases the chances of allocation from clients. An AIF adds value if the strategy is unique and cannot be replicated in the mutual fund structure," said Munish Randev, chief investment officer, Waterfield Advisors. 

Avendus Capital Pvt. Ltd recently collected Rs2,300 crore in an AIF category III fund which relies on simultaneously buying and selling stocks to generate returns.  “The AIF has no restriction on the investment strategy, which enhances the ability of a fund manager to execute. The Avendus Absolute Return Fund can use leverage and short positions in listed equities, which enables us to be present along the risk spectrum where neither PMS or mutual funds can operate," said Vaibhav Sanghvi, co-chief executive officer, Avendus Capital Alternative Strategies—an asset management business of Avendus Capital 

Edelweiss Multi Strategy Fund, DSP BR Enhanced Equity Fund are other examples of a differentiated strategy in a Category III AIF. 

Another strategy in the listed equity AIF basket includes very focussed themes being advised by niche fund managers. “Internationally, there is a trend towards niche managers. In India, we feel an AIF structure can facilitate that access for our clients," said Umang Papneja, senior managing partner, IIFL Investment Managers. “We have introduced AIFs advised by niche portfolio managers who manage focused, thematic strategies. Also, in a situation where expected returns are met sooner than envisaged, a closed-end AIF can redeem the entire investment plus return to investors and fund can be shut down. In contrast, there is a limited dividend a mutual fund can pay out to reward investors, who must wait till end of tenure to exit completely," he said.

Investors who seek out niche fund managers can also go directly to them as most are regulated PMS managers. 

Lastly, one must consider costs. Unlike mutual funds, where cost is non-negotiable by the investor irrespective of the investment, PMS and AIF fees are flexible. With PMS, fee can be negotiated at an individual portfolio level too. Currently, many PMS products work based on model portfolios; so the basic fixed fee structure is comparable to the 2.5% annual expense of an equity mutual fund. 

If there is a profit share arrangement, PMS fixed fee could be lower, closer to 1.5% or so. In case of AIFs, there is a one-time set up fee of 1-2%, an annual fixed fee in the same range, plus a performance-linked fee or profit share. The fixed fee depends on the size of the investment—higher the amount, lower the fee.

The choice comes down to analysing the product and whether it provides a unique solution. The AIF structure has some inherent advantages; you can use leverage, the sponsors must invest their own money, and lastly, it caters to the choice of alternative assets over and above listed securities. Choose the strategy wisely. An AIF that offers an existing proposition on a new platform could be more about packaging rather than a unique choice.

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