This Category Of Funds Is Seeing Heightened Interest From Rich, Large And Savvy Investors

Investments into category 2 alternative investment funds rose more than Rs 42,000 crore in FY23.

<div class="paragraphs"><p>Category-2 caters to a wide variety of investment options.(Source: Unsplash/Isaac Smith)</p></div>
Category-2 caters to a wide variety of investment options.(Source: Unsplash/Isaac Smith)

India's rich, family offices and institutional investors are ploughing more money into category 2 alternate investment funds that include private equity and credit, and pre-IPO financing.

Investments into category-2 funds have risen more than Rs 42,000 crore in FY23 from Rs 1.9 lakh crore in March 2022, according to data compiled by SEBI as of March 31.

"The largest chunk of investments from such AIFs have been getting deployed into private equity, followed by private credit, infrastructure funds, and real estate," said Anshu Kapoor, president and head, Nuvama Asset Management.

Investors are drawn to Category 2 AIFs as these offer multiple options across risk-reward spectrum, and institutional participation leads to higher interest and inflows. It covers investment options like private equity, pre-IPO, private credit, performing credit, real estate and more. As of Sept. 30, 2022, according to NSE data, there were 299 such schemes.

"We are seeing heightened funds flow into category 2 and 3 compared to category 1 as they are both purely commercial funds whereas the latter category's objective is preferred to be for social purposes," said Punit Shah, partner at Dhruva Advisors LLP. Category 3 includes long-only and long-short investments of hedge funds and PIPE funds.

The recent transactions in category-2 funds have projected an internal rate of return between 16-18%, according to A Balasubramanian, managing director and chief executive officer of Aditya Birla Sun Life AMC. The Category-3 funds delivered 4-5% returns last year over their relevant benchmarks, he told BQ Prime.

Aditya Birla Sun Life AMC manages over Rs 1,000 crore across two Category-3 AIFs and over Rs 500 crore across three category-2 real estate funds.

“In category-2 real estate investments, we are focusing more in residential and office projects in tier-1 metro cities, which have either achieved financial closure or (have) all regulatory approvals in place...," Balasubramanian said.

In Category 3 for equity investments, "we are focusing on quality businesses, with ability to grow earnings faster than nominal GDP and ensure ‘margin of safety’ at entry level valuations", he said.

According to him, category-3 AIFs are growing at a faster rate , although on a low base, due to bespoke benchmark-agnostic long-only equity investing options, as well as complex products like long-short investments for enhanced returns.

Not Highly Regulated

The Securities and Exchange Board of India recently issued several circulars related to AIFs, clarifying the standard approach for valuing the investment portfolio to modalities for launching liquidation schemes. The markets regulator also asked AIFs to provide direct plans.

“There are not any significant failures of the funds or something which has necessitated this. I would say it is pure proactive measures, which is taken to prevent any of these either defaults or violations or failures of the industry," he said. "The AIF industry is not highly unregulated or highly regulated, it's somewhere in between.”

AIFs are niche and complex financial products catering to high-net-worth individuals and institutional investors. Investing via regular option means that the investor is receiving help from the distributor. The introduction of a direct plans would increase options for institutional and savvy individual investors.

“It is necessary to maintain balance between growth and governance. Any step taken by the regulator to improve the same and develop the market integrity is always welcome," Balasubramanian said. "We have been actively engaging with regulators on various aspect and issues impacting the growth and governance of AIFs.”