WF: For many IFAs, the term AIF not only signifies "only for HNIs" due to its Rs. 1 crore threshold, but also signifies complex structures - often needlessly complicating matters for investors in an attempt to make a fancy sales pitch as well as receive high commissions. Some HNI oriented IFAs however find certain AIFs very appealing for their clients. What then is the actual proposition on AIFs - how do they really work for client benefit and when do they stop doing so?
Praveen: At the outset let me tell you, that wealth creation ultimately comes from a fund manager's stock picking processes and skills and the growth of underlying companies. Mutual Funds, PMS, AIF etc these are just various types of regulatory licenses that are available to us to create different risk return combinations suitable to a wider segment of investors. On one of the spectrum are mutual funds and on the other end there is PMS which is mostly laissez faire. An AIF is a best of both worlds in between a PMS and an MF. Pardon the longish reply to your question but there are multiple dimensions which I can not answer without first explaining the nuances of these vehicles.
While the "pros" of the features of mutual funds are all too well known, the cons are lesser known. We manage all types of products so I have no favourites but given the opportunity I must explain:
1. Available to all and open ended at all times: A mutual fund being open ended must accept inflows and service redemptions at all times. This means that on the margin on a daily basis the portfolio has to undergo a change to the extent of inflows, outflows and cash positions. While this sounds very logical, it has implications for returns of all investors. On a given day if a fund gets an inflow of 100 crs from that day on the returns of all investors in the fund will depend on how that 100 crs is deployed or where that 100 crs is generated from were it to be a redemption. Further note that when markets are buoyant people insist on giving money and when markets are bad, investors may vote with their feet.
Net-net mutual funds can take some cash sometimes, some may indulge in market timing some not, but on aggregates mutual funds are buyers when investors give money and they are sellers when investors withdraw money. They have their research but they buy what can be bought for the inflow with least impact and they will sell what is easier to sell if the market loses depth.
A PMS or an AIF never faces this situation. An AIF is usually closed ended with a finite corpus like 100, 200, 500, 1000 crs at best and a pre-defined schedule of draw-downs and investments by fund managers. PMS on the other hand has segregated portfolios by clients.
If a client gives me money in the PMS today and I buy say for example ICICI Bank at Rs 320, I will credit those shares at that buying price into the client's demat account. Tomorrow or day after who comes in or who withdraws has nothing to do with this client's investments. If there is an inflow tomorrow it will happen at tomorrow's buying price across the portfolio with no impact on other clients and similarly for a sale, the portfolio of the client who redeems is sold, it is not left to the fund manager to decide what to sell to meet that redemption.
2. Risk, exposure norms and true labelling: Mutual Funds are not allowed to own more than 10% of a particular scrip. Further funds may decide to restrict active positions on stocks and sectors vis-Ã -vis an underlying benchmark in order to keep variability of performance as against the index to a bare minimum and to ensure correlation. Funds also have to adhere to description of underlying investment universe, asset class composition, standardizsation norms etc. All of this results in restricting upside and reducing flexibility in the hands of fund managers.
On the other hand, mutual funds are geared to achieve a set objective and provide relative performance within a universe or an underlying benchmark. On the othe hand, a PMS can be completely without any such bounds and theoretically one can run a PMS with one stock. (We have an outer limit of 20% exposure to a single stock and virtually no sector limits). An AIF restricts 10% exposure to a stock but only at the time of buying, if a stock appreciates the fund can continue to hold it and let it appreciate as per view. The 10% limit in Mutual Funds, sector diversification, various individual limits and strategies imposed by fund houses ensures that there are minimum 12-15 stocks (a must) and as high as 100+ stocks. As you will appreciate, there are no such limits in a PMS or an AIF. Ability to have 12% exposure to a stock vs. say 4%-5% exposure is bound to create different outcomes and no pressure to manage inflows and outflows i.e. ability to hold a position till the investor is with you, is an added advantage.
As you can imagine these nuances can create different outcomes. While there is never any guarantee because I think all lateral width can backfire; for producing attractive outcomes we end up increasing the variability of outcomes. All things being equal if the lateral width is used and plays out, the PMS and the AIF has the potential to outperform a mutual fund.
In our own experience, for long periods of time like 3 years and higher, our PMS has outperformed our own MFs; needless to say with higher risks taken. The AIF, albeit with similar investment strategy, has a much shorter track record of only 18 months but within that limited time frame it has outperformed too, mainly because of owning less than 15 stocks and not having to bother about selling or buying when not desired. Further the AIF was lucky to have a draw down window available where investors are obliged to send in cheques just when demonentisation was announced. As you will appreciate, in an MF investors are not obliged to invest when there is panic in the markets and in a PMS again it's their choice and conviction. In a PMS if they did give a cheque, they would know exactly what would be bought and approximately at what levels the portfolio is accessible live on a password protected portal. An MF tends to be the most opaque about what will be bought, when and at what price.
Coming to high commissions, there are certain misconceptions about the pricing of AIFs and also PMS. Yes, they are not mutual funds and to that extent the pricing is not as standard and straight jacketed. But considering they are meant for sophisticated investors, intermediaries and investors alike who understand the ins and outs can carve a very sweet deal with PMS and AIFs.
Mutual Funds have a straight jacketed pricing structure because of regulations. PMS have no defined pricing structure which is bad, but considering that pricing is free it has tremendous latitude. For instance we can charge NIL fixed fee and only performance linked fees in a PMS or an AIF which is not possible in an MF. Further in a PMS or an AIF, the management fees (may it be fixed or variable) is always calibrated to size of investment which again is not possible in an MF.
I can understand the various misconceptions IFA's may have on AIF's, mainly because it is still in very nascent stage and gaining ground slowly. Most of times AIFs are been offered through banks and wealth management platforms on an exclusive basis within a finite time frame and finite corpus to be raised and hence is not available for offering to larger base through IFA's (at least for now). We will be opening one of our AIFs for distribution by IFAs in Q4FY18.
IFA's will play a crucial role in allocating AIFs to HNI clients and build the AIF industry because they all have a few clients who would be interested in such offerings not only because of the return potential and strategy differentiation but also because of finer pricing for larger ticket sizes which is not possible in a mutual fund.
Currently the AIF industry is over 1.15 lakh crores (as on 30th Sept 2017) which has doubled in last 12 months
Regulator has kept minimum applications size at Rs. 1 crore, this is because certain investment strategies under AIF's can be complicated or technical and may involve leveraged investments which may not suit the risk profile of retail investors.
WF: What are the types of AIF models in India? What model do you operate in and what are your products in the AIF space?
Praveen: There are 3 broad categories of AIF based on the underlying investment strategy and asset class as explained above. Within Category III AIF, investments in listed equities is allowed with various investment strategies like long only, hedge funds with long-short strategies, specific PIPE categories or theme. Due to the rise in equity allocation of investors, the Category III AIFs has recently gained lot of interest in recent months resulting into the category growing from around Rs. 8,081 crore a year back to Rs. 22,656 crore currently.
Given our strengths of bottom up long term stock picking, we only offer AIFs under the Category III and within the category only offer long only equity strategies. The AIF is managed on the broad AMC Investment Philosophy of 'Buy Right:Sit Tight'. We currently manage 3 AIFs launched in last 18 months. We will be opening one of our AIFs for distribution by IFAs in Q4FY18.
WF: What gaps within the retail investment products space do AIFs fill for HNIs? What are some of the inherent advantages of funds?
Praveen: The retail equity offerings are mostly open ended and continuously keep building the AUM and makes it difficult for manager to manage a concentrated portfolio.
Few of the advantages of a listed Equity AIFs are explained below:
Currently 2 investment vehicles available to clients to invest in equities are Mutual Funds and PMS. While the former has its own regulatory limitations in terms of taking exposure to stocks (max 10% in a particular stock and max 25% in a particular sector), the latter has completely no restrictions (you can virtually create a single stock PMS Strategy too). AIFs to our mind enjoy the best of both worlds. Stock level exposure is restricted to 10% but only at the construct level which means that during the course of the Fund, if the stock grows to more than 10% merely because of price appreciation, there is no compulsion to trim down exposure. This bodes well with our style of investing as we like to hold on to our winners. In addition an AIF could participate in Pre-IPOs, IPOs and stocks which have Corporate Actions as money is managed through pool accounts and the holdings are unitized.
MFs are regulated in terms of cost and have a straight jacketed pricing structure (retail as well as Institutional / HNI client is charged same fees) PMS has no defined structure and thus differentiated process could be offered to different clients Further in a PMS or an AIF, the management fees (may it be fixed or variable) is always calibrated to size of investment which again is not possible in an MF.
Unlike a MF or a PMS where the client is typically entering at NAV or taking exposure to the same stocks in the model portfolio respectively, AIFs being closed ended raise money and construct a portfolio at that point in time. It allows the manager to construct a concentrated portfolio of 12-15 stocks without being worried about regular inflows and outflows.
Typically most AIFs have the flexibility of drawdowns at the discretion of the Fund Manager which allows the manager to plan ideation of stocks and portfolio allocation.
WF: In what ways is your equity AIF different from your equity PMS offerings and your equity funds?
Praveen: Although the overarching investment philosophy is same for all our product offerings being it MF or PMS or AIF, we believe AIF in a way is best combination of PMS and mutual funds as clarified above. It offers the benefit of investing in a pool like a mutual fund and also allows the Fund Manager to take concentrated bets in stocks like a PMS.
In an MF or PMS offering the investors are participating in existing allocation or getting aligned to a model portfolio whereas in AIF, we generally launch close ended AIFs customised to suite that market environment, which allows us to construct a completely new portfolio with Buy and Hold approach i.e. with no view of selling in 3- 4 years. This strategy is most tax efficient as well.
WF: How has investor experience been with your equity AIF proposition?
Praveen: We currently manage 3 AIFs on the listed equity space with assets of ~2000 cr. The response from our partners and investors has been encouraging and we have seen traction building up in the AIF space given the ease in setting up (lower documentation than a PMS), operational convenience (unitisation) and execution. We had few of our IFA partners also participating in these AIFs for their HNI clients.
Only one AIF of the 3 that we launched has completed one year and the performance of the same is an IRR of ~32% against the benchmark IRR of ~16% as of September 30, 2017. (Launch date June 30, 2016).
WF: Do you have plans to go beyond long only in your AIF suite and add long-short and other hedge fund kind of strategies that aim for absolute returns?
Praveen: At Motilal Oswal AMC, our investment success comes from bottom up stock picking and buying "High Growth Quality Stocks and holding them for long periods of time. We believe our strength lies in understanding long term businesses and identifying stocks with economic moats. Our endeavor is to generate absolute return with a target for portfolio companies doubling their earnings in 4 years on weighted average basis Such investment strategy creates long term sustainable and predictable returns.
We will continue to manage all our products with the defined Investment philosophy of "Buy Right: Sit Tight" in equity and have no plans to add any hedged or long short strategies.
WF: When IFAs consider AIFs for their HNI clients, what should they look out for in the products to help them differentiate between those that add value to investors and those which perhaps don't?
Praveen: While AIF is nothing but another platform for investors to take exposure to an asset class, in our opinion IFAs should be cognizant of the fact that like any other managed strategy, selection of the Fund House and the Fund Manager is the most important for wealth creation.
As the underlying buy and sell stock transaction of the AIF is taxable under capital gain or business income unlike mutual fund wherein the transactions are not taxable, one should consider an AIF with tax efficient investment strategy.
One should not only choose an AIF considering the complexity of the investment strategy or distinguished underlying assets or marketing attractiveness of the offering, because that is not the only prescription to success, the Investment style of the Fund Manager, the processes that they follow and the predictability of the outcome of the processes are the most critical things that need to be evaluated before investing in the product. The most successful products are outcomes of disciplined repeatable processes.
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