HNI money: Do alternatives deserve a place in your portfolio?

A portfolio mix of debt, equity and alternatives can help earn higher absolute returns

Asset allocation strategies primarily revolve around two major asset classes — equity and debt. But a 70:30 allocation in equity/debt in today’s market dynamics may not be enough to achieve long-term investments goals. In recent times, the attention of savvy investors has moved to another asset class, popularly called ‘alternatives’.

Investments made in avenues such as private equity (PE), venture capital (VC) funds, unlisted shares, REITs (real-estate investment trusts) and hedge funds come under the ambit of alternatives. The alternatives have a low correlation with listed equity/debt. The addition of these to an investor’s portfolio leads to diversification, thus lowering portfolio volatility and augmenting returns. A portfolio mix of debt/equity and alternatives can help investors earn higher absolute returns.

Conducive environment

India has gained the tag of the fastest-growing major economy in the world, and as projected by IMF (International Monetary Fund), is going to maintain that ranking in the near future. Regulatory changes — including the Goods and Services Tax (GST), the Indian Bankruptcy Code (IBC) and the Real Estate Regulatory Authority (RERA) — have eased the way India does business.

The result has been an increased participation of NBFCs and professional managers, leading to huge investment inflows from PE/VC funds. As of January 2019, there are as many as 125 India-based PE and VC funds in the market with an approximate corpus of $18 billion. The aggregate value of PE-backed buyouts and VC deals completed in India since 2009 is $103 billion, which clearly points towards the growth potential (source: Preqin Pro).

The attractiveness of alternative investment arises from its potential to generate supernormal returns, with a considerable amount of risk.

The allocation in alternative investments, from the investors’ portfolio perspective, should not be more than 20 per cent, in order to maintain the diversification in the portfolio at healthy levels.

The alternatives are popularly categorised into multiple sub-asset classes. Venture capital is gaining popularity in India, as investors across the wealth spectrum are looking at proportionate allocations to start-ups and early-stage companies via primary infusion or secondary investment.

VC funds generally prefer the SEBI-approved Category 1 AIF (alternative investment fund) format for fund-raising with an investment term of 5-7 years and a general expectation of 25-30 per cent IRR (internal rate of return).

Private equity investment through the PE fund route is comparatively less risky than VC funds and hence has a lower yield expectation. PE is one of the best diversification tools for an investor’s overall portfolio as it reduces the standard deviation of the portfolio.

The return expectation from private equity funds is around 20 per cent. Real-estate funds have been popular in the AIF format since 2012. These funds have been successful in delivering decent returns and simultaneously helping in portfolio diversification.

Depending on the sector, developer, region and the market, the yields in real-estate funds range from 15 per cent to 22 per cent. With the latest Embassy REIT listing, commercial property RE funds have gained in popularity. These funds offer a stable rental yield as well as capital appreciation on exit from underlying investments.

Absolute returns

The popular absolute return strategy followed by long-short funds has also gained in popularity in the UHNI (ultra high net worth individual) segment. The strategy of the funds are executed in such a way that they can gain from both sides of the market movement, thus generating alpha while completely or partially hedging the net exposure. These funds target a return of around 12 per cent per annum, which can be placed as conservative investment strategies from the investors’ view point.

The surge in investors placing bets on unlisted companies directly and through pre-IPO funds gained popularity in 2017-18. With a target IRR of 20-25 per cent, they offer a popular diversification strategy from listed equities.

To conclude, 8-20 per cent of the portfolio can be in the alternatives for diversification as well as to generate higher returns.

The writer is CEO, Karvy Private Wealth

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