The author is Sakshi Bagdi, third year student at School of Law, Devi Ahiliya Vishwavidhyalaya.
Alternative investment funds have gained popularity in India as investors seek diversification beyond traditional options. SEBI's introduction of AIF regulations in 2012 has contributed to the industry's growth, offering investors with different objectives increased financial sophistication. Despite market volatility caused by the pandemic, AIFs in India have demonstrated resilience and attracted investor interest with benefits such as the potential for higher returns, diversification, unique investment opportunities, and customization options. However, challenges, including limited availability of quality investment opportunities and lack of awareness, must be addressed to unlock the industry's growth potential in India.
This blog examines the growth of the alternative investment industry in India, SEBI's regulatory changes, and potential solutions to industry challenges.
The Growth of the Alternative Investment Industry in India
AIFs are privately pooled investment vehicles that collect funds from investors to invest in different asset classes offering exposure to a wide range of investment options, such as real estate, private equity, hedge funds, and venture capital, which are not available through traditional investment avenues and allow investors to diversify their investment portfolio, manage risk, and potentially achieve higher returns than the market index.
Since their introduction, the AIF sector in India has grown significantly, with assets under management (AUM) reaching INR 2.75 lakh crore as of December 2020. The number of AIFs registered with SEBI have also increased from 17 in 2012 to over 900 as of December 2020. Despite the economic slowdown and market volatility during the pandemic, the investments in the Category-III bucket have grown by 3%, with the best performance of 9% in the last quarter.
The SEBI's Role in Promoting the Alternative Investment Industry in India
SEBI has made AIFs more accessible to investors by introducing a framework for Accredited Investors in November 2020, allowing high-net-worth individuals and institutional investors to invest with lower ticket sizes bringing the Indian AIF sector closer to international standards. The release of the five recent consultation papers on AIFs by SEBI pertaining to investor consent in related party transfers, relaxation of eligibility criteria for key persons, dematerialization mandate for units of AIFs, an extension of periods and transfer to a new scheme for expiring AIFs, and the elimination of double charges for investors in the placement of AIF units provides a valuable resource to investors, fund managers, and other industry participants to make it more investor-friendly. This shows that SEBI is committed to promoting a vibrant and healthy alternative investment industry in India.
Challenges Faced by the Alternative Investment Industry in India
The alternative investment industry in India has shown promising growth in recent years. However, it still faces some significant challenges that need to be addressed to promote inclusiveness and growth in the industry.
Develop a Client-Friendly Tax Structure
The alternative investment industry in India faces a major challenge due to a complex and confusing tax structure that hinders the potential for compound growth and reduces returns for investors. There is a need for a more transparent and client-friendly tax structure that enables informed investment decisions.
To address this issue, the government should work towards developing a client-friendly tax structure that takes into account the interests of investors by introducing tax incentive schemes for alternative investment funds to encourage more investors to participate in the industry to attract more investors and boost the growth of the industry.
Additionally, The government can simplify the tax structure for investors by providing a clear and easy-to-understand tax framework to reduce confusion and uncertainty making it easier for investors to navigate the system.
Promote Inclusiveness through a Comprehensive Regulatory Framework
To foster a more inclusive and thriving alternative investment industry in India, it is necessary to address the current limitations on the number of investors allowed in funds. The government can achieve this by developing a comprehensive regulatory framework that promotes collaboration and networking among investors, fund managers, and other stakeholders. This framework should eliminate the current cap on the number of investors and provide a more dynamic environment that attracts a wider range of investors to the industry.
Additionally, to promote transparency and accountability in the alternative investment industry, a regulatory framework can require AIFs to provide regular reporting, disclosure of fees and expenses, and clear information about risks and returns. Provisions for independent audits and reviews can also deter fraud and misconduct, while requirements for due diligence and risk management can minimise investor exposure to unnecessary risks. A well-designed regulatory framework can also establish standards for investor protection, including minimum capital and liquidity requirements, contingency plans, and complaint resolution mechanisms. Ultimately, this framework can provide a foundation for sustainable growth and development in the industry.
Opportunities in the Alternative Investment Industry in India
Despite the challenges faced by the alternative investment industry in India, it presents opportunities for growth and inclusiveness, particularly for institutional investors seeking stable and long-term benefits. Private equity, venture capital, real estate, and infrastructure investments offer high-growth companies, stable cash flows, and potential for long-term appreciation, making them attractive for higher returns and diversification. Furthermore, alternative investments have less correlation with traditional asset classes, which can help institutional investors to diversify their portfolios and diversify risk. And now, ESG factors have become increasingly important to institutional investors as they seek investments that align with their values and beliefs, generating financial returns and promoting positive social and environmental outcomes. Good ESG practices can generate long-term value as stakeholders incorporate ESG considerations into their investment decision-making.
Regulatory Changes by SEBI
SEBI's recent modifications to India's AIF regulatory framework aim to enhance investor protection, promote transparency, efficiency, and convenience in AIF transactions, and reduce costs for investors. These measures address issues such as related party transfers, eligibility requirements for key personnel, dematerialization of AIF units, the extension of time periods for expiring AIFs, and the elimination of double fees for investors. These proactive regulatory changes reflect SEBI's commitment to fostering a flourishing alternative investment sector in India and are expected to attract more institutional and retail investors, creating a robust and vibrant alternative investment ecosystem in the country.
Increasing Interest from Institutional Investors
There is growing interest of Institutional investors, including pension funds, endowments, and insurance companies in the alternative investment industry in India due to the potential for higher returns and diversification benefits offered by alternative investments such as private equity, venture capital, real estate, and infrastructure. The alternative investment industry in India has become more sophisticated, with experienced fund managers and developers, which has instilled confidence among institutional investors. Demographic factors and economic growth in India present attractive investment opportunities in sectors like infrastructure and real estate. Government initiatives and reforms, such as REITs and InvITs regulations, have created a favourable environment for institutional investors to participate in the alternative investment industry in India. Overall, institutional investors are expected to play a significant role in shaping the growth of the alternative investment industry in India.
.Rising Interest in ESG Investing
ESG investing is a growing trend in India, as more investors seek to align their investments with their values and generate long-term sustainable returns. This trend is being driven by growing awareness and concern about climate change, social inequality, and corporate misconduct, and is being led by institutional investors such as pension funds, endowments, and insurance companies. Impact investing and sustainable investing are two key approaches to ESG investing in India, with renewable energy being one of the most popular themes. Impact investing typically involves investments in companies, organisations, or funds that aim to generate positive social or environmental impact alongside financial returns sustainable investing, on the other hand, typically involves investments in companies that are committed to sustainable business practices. Additionally, companies that engage in corporate social responsibility are increasingly attracting investor attention, as they strive to make a positive impact on society and the environment. Thus, ESG investing is seen as a way to contribute to a more sustainable future while also generating financial returns.
The alternative investment industry in India has grown significantly due to the introduction of AIFs by SEBI, providing new opportunities for investors and companies to raise capital. However, the challenges related to a client-friendly tax structure and inclusiveness faced by the industry need the government to introduce tax incentive schemes and simplify the tax structure while creating a regulatory framework that promotes collaboration, transparency, and investor protection. By doing so, the industry can attract a wider pool of investors and continue to grow, providing higher returns and a diverse range of investment options to investors while contributing to the Indian economy's overall development with a plethora of opportunities for investors and companies alike. With the right policies and frameworks in place, the industry can continue to grow and flourish in the coming years, providing a reliable source of capital for companies and high returns for investors.