The Zerodha founders’ focus on ensuring high absolute returns for investors of their Category III Alternative Investment Fund (AIF), aided by a policy of charging 10% performance fee, is paying off. The AIF called True Beacon AIF One has been active for the past 3 months and is up 8.5% over that time. A Category III AIF is allowed to take derivatives positions (futures and options) and is allowed to borrow for investment purposes.
True Beacon is an equal joint venture of Zerodha’s co-founders Nikhil Kamath and Nithin Kamath. It plans to launch more financial products and services. These include capital markets services to high networth individuals (HNIs) and helping Indians invest abroad. The Kamaths have also roped in Richard Pattle, former Vice Chairman at Standard Chartered Private Bank as senior advisor.
“Over the last 5 years, our personal fund has returned a blended IRR of 55% annually and grown to a significant corpus," said Nikhil Kamath. “The Indian markets have performed well and we worked hard to perfect a basket of strategies for the equities as well as futures and options markets in India," he added.
Kamath emphasized the low costs of the AIF. “True Beacon AIF One is the most client aligned fund in the market -- we are charging zero distribution fee, zero asset management fee, zero entry or exit loads. Our fund depends on a flat 10% performance share which ensures that we are highly aligned with delivering absolute returns to investors," he said.
In order to sustain the low-cost model, the fund has avoided using distributors/agents for marketing. “In order to sustain this business model, we are focusing on direct-to-investor relationships and creating a highly efficient organisation powered by technology as opposed to relationship managers. We will also avoid using upfront commissions for marketing which shall only be by word-of-mouth," Kamath added. SEBI has proposed stoppage of upfront commissions on distributors of Portfolio Management Services (PMS), but the regulator has not yet moved to apply this to AIFs. It has also proposed mandatory benchmarking of AIFs, but only for those funds which have completed a 3 year track record.
Category III AIFs can use leverage (borrow to invest) and can use complex strategies using derivatives (like futures and options). This makes them very high risk products.
Experts have sounded two notes of caution for anyone considering investment in AIFs. “AIFs which have a ₹1 crore ticket size are only meant for ultra HNIs - someone with a financial portfolio of ₹20-25 crore and above, as a diversification tool. It doesn’t make sense for someone with a ₹2 crore portfolio to put ₹1 crore in an AIF," said Amol Joshi, founder, Plan Rupee Investment Services. “Also they are not tax-efficient because their income is treated as business income and applicable tax has to be deducted by the AIF concerned at the highest slab rate along with surcharge and cess," he added.
The 2019 Budget increased surcharge rates on high incomes and in case of AIF, this is applied at fund level rather than at investor level. Thus, an AIF with more than ₹5 crore taxable income may be liable to deduct tax at 42.74% (including surcharge and cess). Investors falling in lower slabs would have to claim any excess TDS back as a refund. Also, investors can consider waiting to see if the fund manager is able to replicate the performance of the proprietary fund before investing.