HNIs want to invest in AIFs as debt funds lose long-term tax benefits

By Aditya Kanoria

Family offices and high net worth investors (HNIs) can now consider alternative investment funds (AIFs) as a realistic option due to the chance to diversify the risk-return mix across asset classes. In addition, investors are interested in portfolio diversification beyond common equities and debt classes to increase returns. AIF investments are driven by this optimism, which has elevated them to an alternative investment asset class.

What are alternative investment funds (AIFs)?

Regular conventional investments like public shares or debt securities differ from alternative investment vehicles. These funds are privately pooled funds that invest in infrastructure, hedge funds, private equity, venture capital, etc.

Debt MFs and AIFs are currently taxed differently at the investor level. While the former is subject to a marginal tax rate, the latter is subject to indexation advantages and a 20% long-term capital gains tax rate (if held for more than three years).

According to the new Finance Bill 2023, the applicable tax rate will remain the same for all categories. Hence the fund’s post-tax return will only be based on its pre-tax return.

What’s driving AIFs in India

India is one of the economies that is expanding the fastest, and it has the third-largest startup ecosystem internationally and a thriving corporate environment. Additionally, Covid has contributed to significant shifts, including the growing use of remote work, the rapid rise of health tech, and the digitalization of all industries. As a result, India’s startup ecosystem is well-positioned to promote digital adoption and serve as the engine of the country’s economy over the next ten years. 

But the infrastructure that complies with international norms is essential for our country to maintain its rapid expansion. AIFs have offered a practical way for investors who want to take advantage of the opportunity presented by India’s development needs to invest much more quickly in public and private infrastructure. While significantly contributing to overall economic growth, this offers investors a rewarding alternative to traditional investments.

Additionally, many firms are preparing for their IPO launches by becoming publicly ready. These are powerful signs that the Indian market is maturing. AIFs stand to gain from changes in the venture ecosystem and the broader infrastructure development initiative driven by public and private entities.

A group of seasoned bankers manages such investments with the necessary skill sets for origination, domain experts, and an experienced investment committee equipped to underwrite manageable risk, ensuring excellent returns. As a result, AIFs are gaining traction among HNI investors. AIFs might be a fantastic investment choice for producing regular, comparatively higher returns with a reasonable degree of simplicity and safety.

Family offices and HNI investors are increasing their investments in areas that offer greater returns on their fixed-income portfolios giving low yields due to the unpredictability and volatility in the domestic equities markets. Thanks to wise investment strategy, AIFs can provide additional alpha through strategic asset allocation into credit AIFs.

The AIF approach ensures that the sponsors have “skin in the game” by tying the interests of the sponsors, investors, and fund managers. By escrowing cash flows and monetizing non-core assets, the investment instruments are conveniently structured to consider liquidity preferences. In addition, AIFs strategically invest in a portfolio of businesses through prompt intervention, which provides the pool with the advantages of diversification, risk reduction, and opportunistic return maximization.

Despite still having a ways to go, investors have begun to embrace India’s growth story, with domestic investors playing a crucial part. As a result, the investment narrative of India is shifting. Although the minimum investment amount for AIF investments is Rs 1 crore (Rs 10 million), small investors may choose to continue investing in debt mutual funds or switch to bank fixed deposits, depending on their tolerance for risk.

Because investments would henceforth solely be picked based on the risk-return matrix and not on tax considerations, the government’s decision has been praised. As a result, AIF investments are essential for HNIs and other investors to gain higher returns and multiple tax advantages.

(Aditya Kanoria, Director, Credent Asset Management. Views expressed are author’s own.)