Hedge fund industry in India is relatively young, and it got a green
flag in 2012 when the Securities and Exchange Board of India (SEBI)
allowed alternative investments funds (AIF). They have the following
features:
High Net-Worth Investors
Only qualified or accredited
investors can invest in hedge funds. They are mainly high net worth
individuals (HNIs), banks, insurance companies, endowments and pension funds. The minimum ticket size for investors investing in these funds is Rs 1 crore.
Diverse Portfolio
Hedge funds have a comprehensive portfolio
of investments ranging from currencies, derivatives, stocks, real
estates, equities, and bonds. Yes, they necessarily cover all the asset
classes only limited by the mandate.
Higher Fees
They work on the concept of both expense ratio and management fee. Globally, it is ‘Two and Twenty’, meaning there is a 2% fixed fee and 20% of profits. As for hedge
funds in India, the management fee can well below 2% to below 1%. And
the profit sharing varies between 10% to 15% generally.
Higher Risks
Hedge funds investment strategy can expose funds to huge losses. Lock-in period generally for investment is relatively long. Leverage used by these funds can turn investments into a significant loss.
Taxation
The Category III AIF (hedge funds) is still not given pass-through
status on tax. This implies that income from these funds is taxable at
the investment fund level. Hence, the tax obligation will not pass
through to the unit-holders. This is a disadvantage for this industry as
they are not on a level playing ground with other mutual funds.
Regulations
It is not required that hedge funds
be registered with the securities markets regulator and have no
reporting requirements including regular disclosure of Net Asset Values (NAV).
How do Hedge Funds work?
Returns from hedge funds stand testimony to the fund manager’s skill,
rather than the market conditions. Asset managers here do their best to
reduce/remove market exposure and generate good returns despite the
market movement. They function in small market sectors to reduce risks
by more diversification. Some of the strategies that hedge fund managers
use are:
Sell short
Here, the manager, hoping for the prices to drop, can sell shares to buy-back in future at a lesser price.
Use arbitrage
Sometimes the securities may have contradictory or inefficient pricing. Managers use this to their advantage.
Invest in an upcoming event
For instance, some major market events like acquisitions, mergers,
and spin-offs among others can influence manager’s investment decisions.
Invest in securities with high discounts
Some companies facing financial stress or even insolvency will sell
their securities at an unbelievably low price. The manager may decide to
buy after weighing the possibilities.
Comparing Hedge Funds & Mutual Funds
Investment Stance
Hedge funds generally have an
aggressive stance on their investments and seek higher returns using
speculative positions and trading in derivatives and options. They can
take short positions (Short Sell) in the markets, while mutual funds
cannot. Short selling allows these funds to benefit even in the falling
markets, which is not so for mutual funds.
Leverage
Mutual funds are safer as they don’t
have much leverage, whereas hedge funds have a huge amount of leverage
and thus attract higher risk.
Investors
Hedge funds are available only to
High net worth investors. Whereas Mutual funds are accessible to the
large group of people. In fact, you can start a SIP with the amount as
low as Rs. 500. In short, hedge funds are comparatively high-risk funds that aim higher returns compared to mutual funds.
For more information on this, visit TAXAJ
Posted by Aashima
Team TaxaJ