Will this sub- ₹10 lakh investment fund rattle hedge funds?
Summary
- Long-short funds which bet on both rising and falling markets are expected to take a bigger hit thanks to the tax edge enjoyed by specialized investment funds (SIFs), and a potentially large target market.
A new investment product designed to hook India's wealthier retail investors may eat hedge funds' lunch given their tax edge and target audience, industry executives said.
Specialized investment funds (SIFs) are a bridge between retail-focused mutual funds and portfolio management services (PMS) targeting the rich. While entry to alternative investment funds (AIFs) starts at ₹1 crore and they are taxed at the highest marginal rate, one can sign up for an SIF with ₹10 lakh, and enjoy the same tax treatment as mutual funds.
Industry experts said that long-short funds, which bet on both rising and falling markets - are expected to take a bigger hit.
"A long-short fund in an SIF will be tax-efficient compared to a long-short fund in an AIF," said Rahul Charkha, partner at Economic Laws Practise. Income earned by Cat-3 AIFs, which work as trusts, are taxed at the AIF level at the maximum marginal rate, Charkha added. Thus, in the case of long-short funds, gains would be taxed as business income at the AIF level at the top rate of 39%, he added.
In the case of SIF, gains from redemptions are taxed at the hands of investors. Therefore, any equity-oriented investment strategies—including the gain on long-short strategies adopted by the SIF—are taxed in the hands of investors as capital gains either at 12.5% or 20% depending on the holding period, excluding surcharge and cess (where surcharge is capped at 15%), he added.
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Avendus Capital recently shut its hedge fund and returned money to investors, while its former CEO Andrew Holland moved to Nippon Life India Asset Management to head its SIF business. Alongside, chief investment officer Nandik Mallik left to join Axis Asset Management as head of equity & hybrid SIFs. While Mallik declined to comment, messages and calls to Holland remained unanswered. A spokesperson for Avendus Capital did not respond to an email seeking comments.
Investors would prefer an SIF over an AIF given the lower entry barrier, said Amit Sahita, director of Fincode Advisory Services. "Even for a ₹1 crore investment, splitting it across 10 SIFs gives better liquidity. For example, if someone needs ₹20 lakh later, they can just redeem two SIFs, unlike an AIF, which locks the entire amount. Also, AIFs often come with long lock-in periods—three to seven years—whereas SIFs offer flexibility with no such restrictions, allowing easier exit if plans change." However, he added that investors might wait for the final rules on taxation, expense ratios and other parameters.
“For someone new to long-short investment strategies, SIFs offer a way to test the waters," said Puneet Sharma, CEO of Whitespace Alpha, who runs a long-short AIF.
According to data from PMS Bazaar, a PMS and AIF distributor, India has 86 long-only Cat-3 AIFs, 35 long-short Cat-3 AIFs, and two debt Cat-3 AIFs as of March.
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Twelve years since their debut in India, the long-short category of hedge funds still has assets of just $3 billion, against global hedge fund assets of around $4.5 trillion. Experts pointed to their stricter tax treatment.
“Globally, hedge funds benefit from structures which enable pass-through taxation, but in India, gains are taxed at the maximum marginal rate at the fund level," said Sharma. He added that limited leverage is another constraint. “In India, leverage is capped at 2x the AUM, whereas in other countries, hedge funds have no such restrictions."
However, SIFs come with limitations, despite their tax efficiency.
“SIFs cannot exceed a gross exposure of 100% of the AUM. So, the total investments--either long or short--cannot exceed ₹100 if AUM is ₹100, in order to protect retail investors," said Vaibhav Sanghavi, CEO of ASK Hedge Solutions, a long-short AIF.
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He added that long-short AIFs can have up to 200% exposure as they are for sophisticated investors who can take more risks. This means the AIF can take leverage of up to twice the AUM, which can enhance returns. Also, a mutual fund can launch only one scheme per category, but an AIF can launch multiple long-short funds.
Currently, there are 35 Category III long-short AIFs in India. The larger long-short funds are Alpha Alternatives Fund Advisors, Nuvama Asset Management, and others.
