What is an alternative investment?
An alternative investment is one that invests outside a conventional portfolio of stock, bond and hybrid funds popularly known as mutual funds. Today, this includes a wide range of investment avenues including real estate funds, private equity, venture capital funds, social venture funds, infrastructure funds and angel funds, and employ diverse, structured and concentrated strategies.
In the past, the venture capital funds (VCF) vehicle was used by many for such alternate strategies. It was only in 2012 that SEBI introduced Alternative Investment Funds (AIF) Regulations, which have gone a long way in providing clear guidelines, mandates and restrictions for the various categories and subcategories of AIFs, making it far more transparent and spurring broader participation into new investment avenues.
Why should an advisor add alternates to her product suite?
Once the domain of only institutions and large family offices, alternative investments continue to grow in popularity and are now making their way into the portfolios of a large number of individual high net-worth investors. India has seen record jump in investments over the last few years and especially in the last two years where AIFs have collectively invested over Rs. 40,000 crore.
There are many compelling reasons for advisors to add alternative funds to their client’s portfolios after assessing their risk appetite which are as follows:
Diversification
Because alternative investments are so diverse, investors have plenty of opportunities to find new investment avenues apart from standard mutual funds/stocks and bonds. Your clients can participate in real estate projects, commodities, infrastructure, start-up business ideas, etc.
Create a well balanced portfolio
Alternative assets often cushion market volatility present in more traditional capital market investments. This can be accomplished by investing in asset classes like structured debt and private equity that have lower correlation to the markets.
Build long term and stable assets
The lock-in period of alternative investments keep clients invested through cycles and reduce knee-jerk reactions of the average investor. Fear-based selling is avoided and clients can potentially make significant gains by staying invested, rather than falling prey to the vicious cycle of greed and fear that an advisor has to manage on an ongoing basis.
Potential for higher returns
By committing patient capital and staying invested through the life cycle of a project or business, investors can potentially earn higher returns. While there may be associated risks of low liquidity, difficulty in pricing, and costly due diligence processes, investors potentially stand to earn a commensurate higher return well in excess of the risk-free rate of return. In the current scenario where yields on fixed deposits and other debt instruments have fallen drastically not even beating inflation on a post-tax basis, it is imperative for advisors to look at some allocation of their clients’ portfolio to such higher yielding assets.
Advisor adding value
Alternatives can be complex and carry different risks than the traditional investments to which most individual investors are accustomed. Financial advisors can demonstrate great value addition by introducing new concepts and ideas that enhance their clients’ overall portfolio. Education is key when it comes to recommending these investments - the good news for financial advisors is that in an environment of heightened volatility and falling yields, investors are eager to be educated!
Building new AUM
There is a clear trend of investors moving from physical assets to financial products that gives exposure to the same underlying asset & return potential but with the added advantage of a shorter investment cycle with a clear exit strategy, access to expert fund management, diversified exposure and participation through an institution rather than on an individual basis. For example, a client can invest in a real estate fund instead of a physical apartment and have the fund manager evaluate, build and manage a portfolio of multiple projects spread across different cities. Through this process, the assets under management of an advisor can grow exponentially. AIFs also tend to be very attractive and flexible in the way advisors are incentivized.
Unlocking the NRI/Offshore opportunity
Recent clarifications from regulators have allowed NRIs and foreigners to invest in a wide variety of AIFs from their rupee assets lying in NRI/NRO accounts or by an inflow through a foreign remittance. This opens up a world of opportunity for advisors as this is an untapped customer segment where the yields offered by such products are extremely attractive compared to returns earned in their home countries.
Positive regulatory environment
Post the original notification in 2012 of AIF Regulations, SEBI further notified amendments to the regulations over the last few years continuously developing AIFs and removing hurdles.
The bottom line is that advisors can now introduce sophisticated investment products to their clients that until recently were only available to institutions and the ultra-wealthy.
Akshay Gupta is Group Executive Head & CEO of Indiabulls Asset Management Company.
The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.