Globally, the alternatives industry has always had two pillars – private equity and hedge funds with the former focused on unlisted securities and the latter on listed markets (equities, commodities and other asset classes). For Indian investors, however, alternatives for all practical purposes has meant private equity and its cousins (venture capital, angel). Hedge funds as a class don’t exist, not because of the lack of demand, but because of the lack of a sensible legal platform. SEBI’s Alternative Investments Fund (AIF) regulations finally change this and give hedge funds a real chance versus private equity managers.
In the past public market managers have had two legal vehicles – the mutual fund (MF) and the portfolio management service (PMS). Launching a MF is a gargantuan task and near impossible for anyone without corporate backing and serious scale. PMS is not even a pooled vehicle – it is managed account structure ridden with operational problems. On top of that, both structures are highly restrictive for a manager – no leveraging, restrictions on shorting and derivatives, intra-day trading and limited assets classes – and only lend themselves to long only portfolios. No reasonable hedge fund manager can operate in the MF / PMS world, and as a result the wings of the alternative asset management industry have been crippled before it even tries to take off.
With AIF Category III funds, managers finally have the basic tools and permissions to create hedge fund structures. More broadly, public vs. private markets managers are finally on a level playing field. For one, as in the PE industry, there is a real incentive for public markets professionals with genuine qualifications but a lack of corporate backing to prove their mettle. The public markets asset management industry has grown from the broker and equity research driven days into a long only dominated space, and there is finally room to go beyond buy and hold. Public and private managers will share a common regulatory structure and potentially the same tax treatment. Most importantly, the same minimum ticket will apply to both (Rs. 1 crore). In the days of yore, PE funds (and real estate funds) were sold by retail distributors at five lakh tickets to investors who had no business investing in private equity. If a twenty five lakh PMS investor cannot take leverage or invest in derivatives, what is the justification for a five lakh investor to buy private equity – an equally risky asset class?
Rightly so, beyond the PE and hedge fund industry, the greatest beneficiary of this stands to be the investor. The right investor will be sold the right products, and a whole new suit of hedge fund offerings will be available to the market – long-short funds, managed futures, 130/30 funds, statistical arbitrage funds and potentially multi asset class funds depending on how regulations shape up. Much of what the Indian alternatives industry has offered are beta products whether it is public or private, and AIF paves the way for true absolute return strategies which are uncorrelated to other asset classes. I do hope the entire ecosystem welcomes the hedge fund industry and give it a chance as they have given the PE industry. The regulator needs to be patient – there will be teething problems but that happens in every industry and should not cripple hedge fund regulations. The wealth management industry needs to be innovative – they have sold status quo, and need to educate themselves and their clients on new opportunities. And most importantly, investors need to be open – for the years of complaining about existing managers and the lack of new offerings, finally, here is something different.
(Radhika Gupta is a founding principal with Forefront Capital Management, an investment manager registered with SEBI. Forefront is India’s first specialized systematic manager and focuses on innovative alternative investment strategies in public markets. . Prior to co-founding Forefront Capital Management, Radhika was a portfolio manager at AQR Capital Management, a $48 billion dollar hedge fund manager in Greenwich (Connecticut), where she traded equities, currencies, fixed income and commodities strategies. Radhika graduated from the University of Pennsylvania with joint degrees from the Wharton School and the School of Engineering.)