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There are 3 categories of AIF, how can distributors/advisors select which fund category to recommend client and under what conditions?
Out of the 3 AIF categories, Category I and Category II are the ones that actually deal with alternate assets. The Category III mostly has listed equity strategies, which isn’t much different from what is offered from PMS and equity mutual funds. For example, you look at long only listed funds other than the structure of AIF and certain nuances, there isn’t much of difference from PMS.
The key challenge for distributors is how to choose suitable strategy among many options available in AIF.
To start with distributors can choose sectors, which are big in growth and opportunity. Since data is not readily available for these, one can follow reliable people in the market, read well researched industry articles by firms like PwC, EY etc.
According to me, private equity funds can be ideal choice for many investors. It is also easy to understand for distributors due to its closeness to listed equity. Private equity invests in unlisted equity in different stages of the company that consists of venture capitals and angel investing, mid growth classically known as private equity and late stage. Among other funds in AIF, there is infrastructure fund, SME fund, real estate fund, funds for distressed assets, social venture funds, these are only for particular sectors. They are very specialized funds meant for very specific types of investors, who are looking for a specific segment to invest in, so if an investor has a need for a particular sector, these can be recommended.
Private equity funds can invest in early-stage startups and growth stage companies and venture capital can also invest in early-stage startups, so which is better and under what circumstance?
All early-stage startups can be called venture capital. Private equity generally includes growth stage startups companies not early-stage startups. So, risk is very different for early stage and growth stage startup companies.
AIF schemes are very tightly positioned so they don’t have mix of two strategies. For early-stage startups schemes, there is more risk and the investor should clearly understand what he is getting into. While growth stage startups are better in terms of risk.
What is the taxation of all the categories? Is there a long term or short capital gains in taxation for AIF categories?
AIF Category I and II have pass through status, which means there is no tax on fund level like mutual funds.
The fund offers capital gains statement to clients, which gives clarity on nature of gains and taxation to investors.
On the other hand, category III AIFs do not have pass through status. So, the taxation is at fund level and uniform tax rate is applicable for all investors.
A report released by CAMS and Equalifi says, many wealth managers have moved from commission led model to advisory model for AIF distribution. It said, “The drop is largely seen in the contribution from wealth manager segments (from 51% to 36%) indicating a higher share of advisory led sales compared to commission led sales. Why is it so?
In good old days, HNIs and ultra HNIs relied on distributors to invest in AIFs. However, these investors are evolved and developed a good knowledge of AIFs. While they want to evaluate the alternates on their own, they still need advisors to shortlist what is best for them. However, they prefer hiring them by paying fees.
What commission can MFDs expect from AIFs?
Commission is very bilateral for wealth managers in AIF. It’s the function of the actual investment opportunity. One has to keep in mind factors like nature of the investor, the ticket size etc. Secondly, a lot depends on the strategy itself, its fee rate, which decides the commission.
How can wealth managers simplify AIF for their clients?
Distributors can graduate their clients having good understanding of capital market to unlisted space. AIFs gives you opportunity to invest in upcoming themes, upcoming sectors, new ideas that are only available in the private space before they get listed. This gives the AIF investors an advantage to make the most of the bright sectors before everyone else does.
What are the risks in each category of AIF?
The biggest risk comes when people invest only due to herd mentality. It is seen that sometimes when equity markets and real estate market boom, suddenly everyone feel the need to be in that asset class. So, trouble happens when people invest without proper understanding of the market and one might end up misallocating in times of volatility.
Secondly, the biggest risk is of lack of liquidity in AIFs, unlike mutual funds, where readjustments and liquidity are present. If you invest in Category I and II AIF, there is a hard lock in period of 3 to 5 years. You can’t really re-balance or adjust your exposure for a certain period of time.
Almost 50% of individual AIF assets were invested in long only funds and long and short funds. Why is it so?
This is because long and short funds of Category III are the easiest asset class to understand for investors who have already invested in MF as this category has listed equity, which is closest to equity markets and has a lower risk.