Unlike MFs, Category-I and II AIFs have a closed-ended structure and are not exposed to the risk of sudden redemptions
Alternative investment funds (AIFs) may gain at the expense of mutual funds (MFs), with the market for credit risk products poised for a shift in their favour.
Unlike MFs, Category-I and II AIFs have a closed-ended structure and are not exposed to the risk of sudden redemptions. This means these can match asset-liability profiles better, making them an attractive proposition for wealthy investors. Currently, credit risk strategies are run in Category-II AIFs and have assets far lower than that in mutual funds.
The problem arises when liabilities are not matched or open-ended, and the loans or investments are of longer maturity, said experts.
"MFs are the wrong platform to have a product like credit risk funds. If you have an open-ended fund, underlying assets of which are less liquid in nature, it is prone to create an asset-liability mismatch. The strategy is more suited to AIFs, which are closed-ended and have a larger ticket size of Rs 1 crore," said Rohit Sarin, co-founder, Client Associates.
"At IIFL Wealth, we have always believed one can’t run credit strategies in an open-ended format. It is important that your assets and liabilities are matched in any business -- whether you are running an NBFC, or a bank or a fund," said Umang Papneja, senior managing partner and chief investment officer, IIFL Wealth.
IIFL AMC had launched a credit fund last year, which has drawn down 65 per cent of the commitment and has Rs 150 crore in cash.
Credit-risk funds try to generate high returns by investing in lower-rated papers. These funds on the MF side witnessed outflows of over Rs 19,000 crore in April after Franklin Templeton wound up six debt schemes. The net assets under management of such funds stood at Rs 35,222 crore as of April 30.
Quite a few AIFs focused on high-yield papers, promising an IRR (internal rate of return) of 15-16 per cent and investing predominantly in mid-sized companies, have hit the market over the past year, according to experts. The demand for similar launches is likely to be muted in the near future, said experts.
"The segment will eventually move to the AIF space and largely become a UHNI (ultra high net-worth individual) product. The shift, however, will take many months as it will take a quarter or two for the current risk aversion to subside," said Ashish Shanker, head-investments, Motilal Oswal Private Wealth.
Sarin believes credit risk funds need to be actively managed, with a lot more due diligence on the part of fund managers while selecting which papers to invest in, and less reliance on external credit rating agencies. "In the MF space, the management has been a lot more passive," said Sarin.
According to Papneja, AIF managers running a closed-ended fund, with cash to deploy, have good opportunities at present without the need to take undue risks. For example, bonds of Embassy Office Parks REIT, India’s first listed real estate investment trust, is AAA rated by CRISIL and its bonds briefly traded at 11.25 per cent in the secondary market. A manager can quickly take advantage of such opportunities.
Some like Joydeep Sen, founder at wiseinvestor.in, feels that credit AIF strategies may find only limited takers among UHNIs.
MFs also score over AIFs when it comes to taxation. Long-term capital gains on debt fund are taxable at the rate of 20 per cent after indexation. Indexation is used to factor in inflation from the time of purchase to sale of units. The income from AIFs will be added to the earnings and taxed as per slab rates.
“AIF investors will be at a tax disadvantage unless they exit through the exchange route. In such cases, the premium or coupons will be subject to a capital gains tax of 20 per cent,” said Shanker.
AIFs are privately pooled investment vehicles, which collect funds from sophisticated investors, whether Indian or foreign.
Investments by AIFs rose to Rs 1.4 trillion for the quarter ended December 2019, clocking a 53 per cent rise in assets over the year-ago period.