Category III AIFs more popularly known as hedge funds employ diverse or complex trading strategies by investing in listed and unlisted derivatives. They are also allowed to employ leverage strategies i.e. borrowing to invest. Currently, they can borrow 200% of the fund size.
Category III AIFs are often synonymous with hedge funds, but in practice there are two kinds of Category III funds. First, there are long-only funds where AIF fund managers run thematic long-only ideas like an equity mutual fund but with lighter restrictions. Second, there are hedge funds, which use strategies far more complex than a typical mutual. These funds use strategies such as long-short derivatives and leverage to give returns with minimum risk.
Long-only funds
A bulk of the registered funds in Category III are long-only entities. This is largely because AIFs have given an opportunity to fund managers with an entrepreneurial spirit to start their own fund house.
Some of the prominent names include Kenneth Andrade who left IDFC MF to start Old Bridge Capital, Prashant Khemka who left Goldman Sachs offshore arm to start White Oak Capital and Sunil Singhania who was with Reliance MF before starting Abakkus Asset Managers.
Another factor that has catalysed the popularity of long-only funds is that equity mutual funds come with regulatory constraints, e.g. MFs can only have one fund per category, which limits room for style diversification.
As a result, sponsors of around 15 MFs are using Category III AIF as a platform to offer thematic and close-ended funds.
Motilal Oswal Asset Management, ASK Investment Managers, ENAM Asset Management and Alchemy Capital are some of the largest players in this sub-category.
Long-short funds
Among long-short funds, the AIF industry is largely evolving on two popular tracks based on asset allocation: equity long-short funds and debt-risk long-short funds.
The debt-risk long-short funds hold debt papers primarily, with a net exposure of 5% to 25% and compete against an arbitrage fund or short-term debt fund.
The equity-risk long-short funds hold cash equities primarily, with the net exposure ranging from 50% to 100% and compete against large cap equity funds.
Edelweiss, Avendus and DSP are the pioneers in long-short funds in India.
How have Category III AIFs fared so far?
AIFs started their journey in India in 2012. Since then, commitments raised under Category III AIFs have reached Rs.43,254 crore as on March 31, 2019. The amount of funds raised stood at Rs.36,866 crore and investments made stood at Rs.30,801 crore.
Commitments raised under Category III AIFs is the second highest among all three categories. It accounts for 15% of commitments raised under all three categories.
Who can invest?
The minimum ticket size for an investor who wants to deploy money in Category III AIFs is Rs.1 crore, making it accessible to only a handful of investors.
Besides Indians, foreigners and NRIs can invest in this category.
Structure and regulation
Category III AIFs can be open-ended or close-ended funds. If it is a close-ended fund, the minimum tenure has to be 3 years. The AIF has to disclose to its investors upfront, whether it will be an open-ended fund or close ended fund.
Each scheme in this category should have a corpus of at least Rs.20 crore.
A Category III AIF can take leverage positions of up to two times the total fund corpus. For example, if the total corpus of the fund is Rs.100 crore then it is allowed to take leverage positions of up to Rs.200 crore.
Category III AIFs have to disclose to investors the total leverage that has been employed.
It is not mandatory for Category III AIFs to make their earnings reports public on a regular time interval.
Features:
A high risk-high return investment
Low liquidity
Long investment horizon
A chance to have a diversified portfolio