Jordan puts it creatively: when times are tough, you have to be flexible and adaptable. The volatility gripping global markets has everyone in investing on edge. It appears that the Alternative Investment Funds (AIF) industry is poised to handle the wild market turbulence with its diverse product line, larger pool of capital, greater flexibility in allocation and management of higher risks.

AIFs, which began in 2012 after market regulator Sebi framed AIF regulation, have grown by 20% annually over the past decade. Category I of the AIF covers seed funding and includes venture capital, social enterprises and small and medium-sized enterprises (SMEs). Tier III, which covers hedge funds, represents 13% of the sector’s assets under management (AUM) and Tier II, which covers private equity funds, 77%. The AUM for alternative investments is estimated at $54 billion, which represents less than 4% of India’s public market capitalization as of March 2020. The low AUM is mainly due to the fact that the minimum investment size for investors, ₹1 crore is high.

The rapid growth of AIFs has been driven by demand for private equity (PE) and debt. Investors prefer AIFs because their portfolios of listed stocks are more focused or thematic and tend to be more independent of benchmarks than mutual funds (MFs). The rampant growth of the PE has been mainly driven by new-age tech startups which are mostly unlisted and therefore only available through the AIF route.

Falling yields on fixed income instruments and extremely stretched equity valuations have also contributed to the surge in private equity investments. Increased liquidity as global central bankers adopted accommodative monetary policy also helped the sector. Venture investors have been looking for pre-IPO deals. To add to this, InvITs and REITs caught the eye of investors as the debt market remained tepid. Additionally, the reduced ticket size has helped investors gain access to new products.

Venture capital funds have also raised pledges of ₹34,569.56 crores in December 2021, a jump of 29% from the same period last year. The AIF capital pool has expanded, supported by M&A activity in the country. Takeovers by Tatas ($1 billion Big Basket) and Reliance Industries ($200 million from Dunzo) helped PE/VC exits. Moreover, the listings of Zomato and Paytm in public markets have encouraged many start-ups to aim for a successful listing, increasing the likelihood of easy exits by investors. The allocation to OFIs increased due to the expanding investor base of private debt markets in India.

These events boosted AIF industry sentiment. Also, new funds have been raised and new managers have appeared. The new managers prefer to set up an AIF and raise capital from national investors backed by their local networks. Additionally, wealth management firms raised pre-IPO and late-stage AIFs to the tune of $1 billion by reaching out to a broader client base. New investors were attracted by the short investment horizons and the visibility of the exit in the public markets. Private debt allocation is driven by falling yields on AAA-rated or quasi-government debt securities. It was also helped by the inability of MFs and non-bank financial companies to participate in a number of transactions due to changes in market dynamics and regulation after the IL&FS crisis. Comparatively, alternatives like real estate and gold have lost their luster. In addition, AIFs have reduced their gestation periods for the convenience of private market investors. Category III – long only or long short equity funds (hedge funds) offer diversification as they employ diverse and complex trading strategies and leverage through investment derivatives.

Separately, the categorization of start-ups in lending to priority sectors also boosted liquidity. AIFs raised a total of ₹6.09 trillion, up 38% from a year earlier, according to December 2021 data compiled by Sebi.

Hedge funds are gaining momentum and growing rapidly in terms of AUM. These are preferred as they are lower risk and also offer alternative games. Alternative yield options like InvIT and REITs provide stable cash flow at a time when fixed income yields are unattractive. Hence, access to a wider pool of capital, especially global flows, expanding private markets and greater investment flexibility are fueling the rise of OFIs as India’s new MFs. .

Alok Saigal is President and Head of Private Wealth, Edelweiss Wealth Management.