HEDGE FUNDS: The Current Indian Landscape
Most of you must have heard about mutual funds, if not, you can refer to our previous article. However, hedge funds feel like a distant sophisticated financial structure. Ever seen a hedge fund advertising about their services? They are not permitted to do so. Let’s have a walk through of the current Hedge funds landscape in India and what all you need to know about it before making an investment decision.
Hedge Funds are still in its initial phase in India and are not as popular as mutual funds. They also pool money from investors, however, ‘hedge’ risk and deliver higher returns using complex strategies. ‘Hedge’ refers to protection against risk.
Can retail and small investors invest in hedge funds ?
Retail investors cannot invest directly as hedge funds pool money from accredited investors including banks, insurance companies, high net worth individuals, endowment and pension funds. Hedge funds function as private partnerships and are not required to register with SEBI, nor do they need to disclose their NAV periodically like other mutual funds.
Since, they are required to hedge risk for investors, it requires aggressive management and hence, higher management fee. If you are thinking of investing in hedge funds, you should be someone financially well off as well as an aggressive risk taker as hedge fund managers take short and long positions at dizzying speed to keep up with market movements.
The strategies followed are highly complex making it riskier to invest. Also, since hedge funds don’t follow transparent policies and hedge managers have more flexibility than mutual fund managers, it is difficult for retail investors to indulge. However, don’t worry if you want to invest and enjoy the benefits of hedge funds, you can invest through Funds of funds. Funds of funds invest in hedge funds pooling money from small investors to provide them diversification benefits.
A hedge fund can use leverage, take short equity positions, long or short positions in derivatives to get a higher return. They are less liquid than traditional investments and usually involve a lockup period or a notice period of around 30-90 days with redemption fees to cover the transaction cost. Apart from management and redemption fees, hedge managers also charge an incentive fee based on returns. This makes it difficult for small investors to earn through hedge funds.
There are currently many obstacles for hedge funds to grow in India. The first one being heavy taxes levied on returns from alternative investments making it more difficult for hedge fund companies to attract investors. The levy was increased by a fifth to 42 per cent during July last year.
To all the aspiring Hedge fund managers if you have been following the hedge fund market for some time, here's a little statistics we would like to share and get your eyes rolling. Domestic hedge-fund assets dropped 6 per cent to $4.6 billion last year which is the biggest decline since 2011. Apart from this, more stringent rules for hedge funds as compared to peer countries, shortage of derivatives also hampers fund managers in taking long short positions due to which India’s long short funds perform even worse.
Despite all these difficulties, hedge funds might appeal to investors looking for shelter in a turbulent market. Lowering the tax rate for the funds would go some way toward helping build liquidity in India’s equity market. The industry has a great potential for growth if the government and regulators understand the issue and find an appropriate solution.
Before selecting a hedge fund, it is essential that you consider the investment strategy, process, method of valuation, assets under management, growth plan, appropriateness of benchmark, etc which can be complex and challenging.
We hope that this helped all the aspiring investors to know more about hedge funds and influence your financial planning decisions.