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The opportunity to expand the risk-return mix across asset classes has made alternative investment funds (AIFs) a viable proposition for family offices and high networth investors (HNIs). In fact, there is a visible appetite among investors towards portfolio diversification beyond traditional equity and debt classes and improved returns. That optimism is driving the investments in AIF space and has turned them into an alternative investment asset class.

As per Sebi (Securities Exchange Board of India) data relating to activities of AIFs till 31 December 2021, total assets of AIFs have gone up to 6.09 trillion in Q3 FY22 from 5.35 trillion in Q2 FY22. From the year-on-year perspective, it’s a 38% growth from total AIF assets in Q3 FY21, which stood at 4.41 trillion.

The propensity of the investors to explore beyond traditional investment has bolstered the growth outlook for AIFs as well. As per the PMS Bazaar report, the total assets of AIFs structures will likely exceed 50 trillion in the next 10 years. AIFs have indeed emerged as an effective investment instrument for wealth creation thanks to standardization and availability of detailed information on AIFs structures.

As AIFs don’t correlate to the stock market, they help investors alleviate volatility. With robust diversification and inflation hedging, the rate of return prospect in AIFs is higher than that of traditional investment avenues.

Because of the uncertainty and volatility in the domestic equity markets, the family offices and HNI investors are expanding their investments into avenues that provide better returns on their fixed income portfolios delivering low yields. AIFs can generate additional alpha through strategic asset allocation into credit AIFs thanks to intelligent investment strategy.

The AIF route ensures the sponsors’ “skin in the game" by interlinking the interests of sponsors, investors and fund managers. Convenient structuring of the investment instruments considers liquidity preference through escrow of cash flows and non-core asset monetization. Since AIFs strategically invest in a portfolio of companies through timely intervention, the benefit of diversification, risk mitigation, and opportunistic return maximization accrues to the pool.

The reason why AIFs are strengthening traction among HNI investors is that such investments are guided by a team of seasoned bankers equipped with the required skillsets for origination, domain experts, and an experienced investment committee equipped to underwrite manageable risk, thus ensuring excellent returns. AIFs can be an outstanding investment option for generating consistent, relatively higher returns with relative convenience and safety.

Among all the categories of AIFs, Category II AIFs are generating maximum interest from the investors. As per the cumulative net figures as at the end of December 31 2021, released by Sebi, total assets of Category II stood at 4.95 trillion, accounting for 81% of the total assets of 6.09 trillion. Category II AIFs investment has witnessed a year-on-year increase of 40% in Q3 FY22 from that of Q3FY21, which stood at 3.52 trillion.

Category II AIFs comprising real estate funds, private equity funds (PE funds), and funds for distressed assets cut the risk profile by providing a diversified investment portfolio. As a result, these AIFs are considered a defensive investment option and an effective hedging mechanism.

On the other hand, credit AIFs offer ease of investment due to the pooling of capital, which can defer the high cost involved in the set-up, under-writing, diligence, legal documentation and fund administration. Besides being isolated from the volatility of the equity markets, investments by Credit AIFs are typically secured with 1.25-3.5x asset cover besides other equity collateral. Credit AIFs can offer a return in the range of 14-15%.

The awareness of AIFs is gradually increasing among the family offices and HNIs in India, eventually strengthening the discoverability prospect of this volatility-hedging investment avenue. As per the Private Market Monitor Report released by trica, there are more than 140 formalized family offices in India. The growing acceptance of AIFs will turn out to be a key driver for HNI and UHNI capital allocation into private market investment opportunities.

Nirmal Gangwal is managing partner at Brescon & Allied Partners LLP.

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