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BW Businessworld

How The Rich Get Richer

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Savvy investors and private bankers could not believe what they heard that muggy October afternoon, four years ago. Options Maxima, supposedly an infallible structured investment product designed to trade in equity options and deliver 15-18 per cent returns every year, had sunk, causing portfolio losses to the tune of Rs 45 crore. 
 
What followed in the next few hours had all the makings of a racy Hollywood flick. Options Maxima was structured by the wealth and portfolio management schemes (PMS) vertical of a corporate-backed financial services firm. When the chairman of the group found out about the losses, he called for an urgent meeting with his core team.

A few hours into the huddle, the executives managed to hammer out a solution. They decided to take the losses on their books and return investors their money.

Investors of Options Maxima were lucky to get their money back. Only because the broking outfit belonged to a large corporate with a reputation to protect. Not many investment product companies do that. This is where regulators come into play. Market regulator Securities and Exchange Board of India (Sebi), in its attempt to exercise control over investment product administrators, launched the concept of alternative investment funds (AIF).

“AIFs are very well regulated; funds operating in this sphere have to be registered with Sebi,” says Radhika Gupta, founder of Forefront Capital Management, which was recently acquired by Edelweiss Financial Services. “AIFs are definitely not as risky as structured products. AIFs are relatively more liquid than structured products.”

The AIF Bandwagon
When Sebi launched AIFs in 2012, it enabled asset managers to bundle investment products with any conceivable asset class as the underlying. While there aren’t many exotic products, in the last two years product manufacturers have rolled out investment options in private equity, venture capital, social venture capital, real estate financing, infrastructure capital pools and SME funds.

Apart from the regular themes, there are about half a dozen ‘long-short’ absolute-return funds, a few arbitrage schemes, some long-only investment plans, a handful of credit opportunities funds, a few distressed assets funds and a couple of rental yield pools. Cinema funds — launched by HBS Raksha Movies, Third Eye Cinema and Dar Mentorcap — add to the glamour quotient of the existing array of funds.

“Having a bit of exposure to risky assets is good, but investors should know what they are getting into. Some of these products/strategies have no performance track record to help analyse the outcome. Others like cinema funds or art funds are pure bespoke ideas,” says Narayan Shroff, director at Barclays Wealth. “You will need an investment advisor to wade through the clutter,” he warns.

AIF is broadly classified under three categories, depending on the nature of funds, return profile and investment cycle and objective. The three-tier classification is not an indicator of the inherent risk involved in investing in any of these categories.

“The third category comprising hedge, long-only and arbitrage funds is very interesting. This category is new and evolving,” says Gupta.

But Shroff is wary of category-3 funds; they tend to get complicated, he says. “These funds take leveraged positions and, in the process, take a lot of risk.”

Since its tepid launch two years ago, AIF has managed to attract rich investors and cash-rich institutions. As per official scrolls, 106 asset managers have secured Sebi approvals to launch the fund.

In terms of investments, AIFs have secured commitments worth Rs 13,465 crore, which will be drawn from investors at various points during the investment cycle. So far, around Rs 4,500 crore has been drawn from investors, of which Rs 3,300 crore has been deployed.

“Investors are slowly warming up to the idea of investing in alternative asset classes. Long/short strategies, real estate investment funds and high-yield debt products are getting popular among rich investors,” says Prateek Pant, director of products and services, RBS Private Banking.

“Many of these strategies are non-liquid or for a specific term. Now that’s a big risk. Many of these funds adopt arbitrage strategies that can go wrong. Funds investing in unlisted equity could face exit problems. So it’s not advisable to invest more than 10 per cent of one’s portfolios in alternative funds,” adds Pant.

A Rich Man’s Play
AIF providers are not allowed to accept investments below Rs 1 crore, restricting the segment to the rich. At all times, asset managers have to keep a minimum corpus of Rs 20 crore and no fund can have more than 1,000 investors. The firms can list their units on the bourses for better liquidity, but the minimum lot size has to be Rs 1 crore.

Most alternative funds have exit loads, which means premature redemption is charged. These are often in the range of 3 to 5 per cent of the net corpus. Asset managers levy fund management fees between 2 and 5 per cent every year. They also skim a portion of the profits generated — mostly 15-20 per cent of profits after a ‘profit hurdle rate’ of 12-15 per cent returns per annum.

Wealth managers like Shroff and Pant believe funds have to generate gross returns in excess of 20 per cent to make a case for investing in AIFs.

Strategies & Returns
Absolute return funds are a hit among rich investors. They invariably adopt a long/short strategy, which involves taking long positions in stocks expected to rise and short positions in those expected to fall. While the strategy is simple, it can go horribly wrong if the fund manager gets his directional calls wrong.

“We have generated positive returns every single month over the past one year, making more money on our longs than the shorts. We are quite aware of the risks involved in this strategy,” says Andrew Holland, CEO at Ambit Investment Advisors, which manages a Rs 150-crore absolute return fund. 

“We do not believe in taking unwanted risks; our effort is directed at delivering consistent returns,” adds Holland.

Funds such as Malabar Capital Trust and Avendus Capital do not believe in taking leverage risks. Both the asset managers adopt pure ‘long only’ strategies while managing funds.

“We are a long-based fund, with actively managed cash levels. Our portfolio is structured to hold 10-15 mid-cap stocks, actively managed and rebalanced as per market conditions. Our holding period is six years, but we expect to start returning money to investors from the fourth year onwards,” says Akshay Mansukhani, partner at Malabar Investments.

Echoing Mansukhani, Shrikant Bandaru, principal at Avendus PE Investment Advisors, says: “We will only look at companies that post 20 per cent growth every year. Our target is to generate 20-25 per cent gains every year.”

Private equity, venture capital and infrastructure funds offer good investment options in the unlisted space. These investments may have long holding periods but their targeted payouts are higher compared to category-1 and -3 funds.

“Return expectations have declined post the economic downturn.  These days, funds target 20 to 22 per cent returns a year,” says Archana Hingorani, CEO of IL&FS Investment Managers.

“Everything boils down to the vintage of the fund. If the fund manages to get an upswing in the market cycle, it will generate better portfolio returns. For instance, the 2012 vintage funds will see better outcomes in terms of performance,” says Hingorani.

Socially conscious investors can invest in venture funds that work towards creating a social impact. These ‘for-profit’ social venture funds invest in areas such as healthcare, education and skill development. “Investors should be socially inclined to appreciate such funds. They should be willing to wait for seven to eight years to get their money back,” says Mani Iyer of Incube Connect Fund.

The best of social venture funds target just about 12–15 per cent returns per annum.

If ideas could make you money, cinema funds definitely will. The fund finan-ces production, marketing and distribution of films.

“Only 82 (of a few hundred films produced) were released in 2012. Several good films couldn’t be released due to paucity of funds,” says Kewal Handa of Third Eye Cinema Fund. “Bollywood films like Kahaani, Queen and Fukrey found few takers initially; but when these hit the screen, distributors made a lot of money. We intend to buy good films and distribute them across the world. Our revenues will come from theatres, satellite rights, gaming rights, TV rights and library rights.”

Third Eye Cinema Fund hopes to raise Rs 200 crore over the next few months. The fund targets 25-30 per cent return every year and hopes to payback investor funds in three years’ time.

Asset managers talk up their investment strategies all the time to bring in new investors. But investors should understand the product well before committing money to alternative funds.

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(This story was published in BW | Businessworld Issue Dated 06-10-2014)