Generational wealth planning with AIFs

The growth of Alternate Investment Funds (AIFs) in India’s financial universe over the past few years has been spectacular. Nearly 200 AIFs were approved by the regulator in 2023-24 alone, taking the total number of registered AIFs in India to around 1,300. An AIF basically puts together investors' money just like mutual funds but is able to provide exposure to a much bigger set of asset classes which otherwise would not have been available for investment. These include unlisted firms, hedge funds, private equity etc. offering the potential to earn higher returns.
 

What Makes AIFs Suitable for Generational Wealth Planning?

By virtue of being able to invest in asset classes beyond the ones that are traditionally available to everyone like stocks, gold, bonds, the AIFs allow the wealthy and high net worth individuals to profit from the “future” opportunity. Hence, they are a good option for creating generational wealth. Take for example the new age startups in food delivery - while one of the firm has already listed and offered stellar returns, another is on the verge of being listed. For AIFs, that would have spotted this opportunity well in advance, the gains made through such an investment in an unlisted company may potentially be very big. This of course assumes the risk that the unlisted company will also be able to garner similar valuations as the listed one given that there is a long runway ahead for home-delivery of not just food and grocery items but even just-launched iPhones. And this appetite to get things fast (even if on EMIs) may only grow as many even younger people prefer to stay home and avoid the parking and traffic woes that are increasing in not just metro cities but even in Tier-II cities.
 

Diversifying Wealth Through AIFs for Future Generations

If chosen and monitored well AIFs can be a great asset class to build wealth for generations. Given that they diversify so much more than Mutual Funds, AIFs are often able to spot the opportunity much in advance. They can also play around with venture capital, real estate, and commodities if they want to, producing a strong alpha over the typical market returns. Because they are invested in multiple assets they also hedge their risks. Often AIFs can also be shaped for the needs of a family keeping in mind how much risk they can take and invest accordingly. Besides they can also be tuned for tax-efficiency keeping in mind the ever-changing government policies. AIFs can also be used to pass on wealth to future generations while reducing estate levies as much as possible.
 

Risk Management in AIFs

Investing in AIFs must be done carefully and one must study not just the track record but the pedigree of the fund house, management stability, and the core focus areas as also costs. One must also track this investment and any news related to the fund house carefully to ensure things are going smoothly and the AIF is delivering on its stated objective. Most AIFs focus on the long-term wealth generation but this needs some supervision on the part of the investor and peer comparison. Also do keep in mind that unlike the mutual fund industry, AIFs do not have a cap on how much they can charge the customer so you have to be prepared to shell out a lot of money for seeking higher returns. The total expense ratio can be way higher than the 2% average that many Mutual Funds charge for their regular investment plans and often less than half of it for their direct plans. There can also be caveats like profit sharing where you pay the AIF for the profit generated annually.  

Do AIFs Outperform Traditional Investments in the Long Run

Like most market-linked instruments there is no surety that AIFs will provide a higher rate of return. What gives them the edge over others is that AIFs are headed by extremely talented management teams with a deep understanding of the financial world. The hope then is that they will manage the funds in such a way that they spot opportunities before others do and exit at the right time generating the most bang for the invested buck. Rating agency CRISIL says AIFs have generated substantial alpha compared with the PME+ universe. As of March 2023, it notes, the aggregate benchmark was able to generate an alpha of 13.5% over the public market index (S&P BSE Sensex TRI).

“This performance is not driven by a few funds — distribution of alpha recorded by funds in the benchmark over their respective public market equivalent reveals that more than 75% of the funds have generated positive alpha,” it said in its 2023 report on AIFs.

To be sure industry observers say that comparing AIF performance can be tricky because unlike Mutual Funds their data sharing is not as public, intense and granular. Also because AIFs adopt varying strategies clubbing them and then comparing them against each other is much more difficult.

How AIFs Can Complement Real Estate and Stock Investments

Sebi mandates that Category I AIFs include venture capital, SME, infrastructure, and social venture funds, Category II AIFs invest in various asset classes like equity or debt but avoid leverage or borrowing to invest in risky assets and Category III AIFs can use leverage or short selling to generate returns. The first two are typically for a long seven-plus year horizon while the latter go for around 3.5 years. When you have already had exposure to the listed universe of stocks and real estate, AIFs can provide you with exposure to areas that are beyond the common investor’s limits and help generate wealth in the long term.
 

Conclusion

AIFs are a great tool to tap the potential of a growing market like India where economy is expected to grow at around 6-7% for the coming years and massive investments are taking place both in soft and hard infrastructure. Many startups are being incubated and then listed, unlocking value for investors. And many more are trying to find solutions to everyday problems and using technology and AI to transform lives and that is a very big opportunity for decades to come.