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Tata Capital > Blog > Wealth Services > Exploring the pros and cons of investing in long-short Alternative Investment Funds (AIFs)

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Exploring the pros and cons of investing in long-short Alternative Investment Funds (AIFs)

Exploring the pros and cons of investing in long-short Alternative Investment Funds (AIFs)

Investing in long-short alternative investment funds (AIFs), Category III funds, is gaining popularity among Indian investors who want to diversify their portfolios and better manage risks. These funds let managers take both long and short positions in different assets, offering a unique investment strategy that can lead to high returns. However, like all investments, Long-short AIFs have their pros and cons. This article will explain what long-short AIFs are and their benefits and drawbacks.

What is an alternative investment fund (AIF)?

Before switching your investments into a long-short AIF, it is essential to understand what an alternative investment fund is. An AIF is a type of investment fund that collects money from investors and invests it in areas other than the standard options, such as shares, bonds, or fixed deposits. Generally, AIFs invest in assets, including real estate, private companies, hedge funds, startups, and specific projects. Investors willing to take higher risks to earn higher returns should consider investing in AIFs.

AIFs differ from mutual funds as they adopt flexible investment strategies. Professional fund managers manage these funds, and their decisions are based on market opportunities. In many countries, AIFs are regulated by financial authorities to protect the investors’ interests.

AIFs demand a high minimum investment amount. This makes them the ideal choice for high-net-worth individuals and institutions. They also have a longer lock-in period, meaning you cannot withdraw money easily.

Types of alternative investment funds in India

In India, the Securities and Exchange Board of India (SEBI) classifies alternative investment funds into three main types. These categories are based on the type of investments they make and the associated risk.

  1. Category I AIFs: These funds invest in areas that support economic growth. Some common Category I AIFs are venture capital funds, social venture funds, startup funds, infrastructure funds, and SME funds. Since these funds focus on development, the government encourages the investment through tax benefits and relaxed investment rules.
  2. Category II AIFs: This AIF type invests in private equity funds, debt instruments, or other AIFs that do not fall under Category I or III. These funds usually have a medium level of risk and do not use heavy borrowing. They operate flexibly, but they must adhere to standard SEBI compliance.
  3. Category III AIFs: These funds use complex trading strategies and may invest in shares, derivatives, or hedge funds. They aim for short-term returns and carry a higher risk. As a result, they are suitable only for experienced and well-informed investors.

Overall, these three types help investors choose funds based on their risk and return goals.

Alternative investment funds list (Popular AIF examples in India)

Many popular AIFs in India attract high-net-worth investors. These funds invest in areas like private equity, real estate, startups, and hedge strategies. The following alternative investment funds list comprises names of different funds across the three categories:

  1. Category I AIFs invest in high-growth ventures and early-stage funds
    1. Negen Angel Fund
    2. Pipe Serica Angel Fund
    3. Finvolve Growth Opportunities Fund
    4. India Discovery Fund – II
  2. Category II AIFs invest in private equity and private credit strategies
    1. Singularity Investments Fund of Fund
    2. Unicorn India Ventures Fund
    3. Bharat Value Fund
    4. Nine Rivers Capital Aurum Rising India Fund
    5. 360 ONE Asset Early-Stage Fund
  3. Category III AIFs invest in listed equities using either long-only or long-short strategies
    1. Ampersand Growth Opportunities Fund
    2. Negen Undiscovered Value Fund
    3. Sameeksha Equity AIF
    4. ICICI Equity Opportunities AIF
    5. 360 ONE Equity Opportunity Fund

What is a long-short AIF?

Long-short AIFs are a type of hedge fund that involves taking long positions (buying securities expected to increase in value) and short positions (selling borrowed securities expected to decrease in value). The goal is to profit from rising and falling markets, providing potential for higher returns and risk management through diversification of market positions.

For example, an investor might identify Company A as undervalued and Company B as overvalued based on fundamental analysis. The investor would buy shares of Company A, expecting its stock price to rise (long position), and sell shares of Company B, anticipating a decline in its stock price (short position).

By balancing these positions, long-short strategies aim to generate returns regardless of the broader market trend.

Pros of investing in long-short AIFs

Investing in long-short AIFs offers several advantages that can improve an investor’s portfolio.

  1. Portfolio diversification

Unlike long-only strategies, a long/short investment strategy allows managers to buy stocks and bonds they expect to outperform the market while simultaneously shorting assets they predict will underperform. This approach broadens the investment opportunities, potentially creating a more diversified portfolio that is less tied to the fluctuations of traditional equity and fixed-income markets.

  1. Potential for excess returns

Long-short strategies can profit in rising and falling markets, which can result in higher returns. However, this approach also carries an increased risk of significant losses, particularly if both the long and short positions perform poorly.

  1. Short selling permitted

Unlike many mutual funds, where short selling is prohibited, long-short AIFs permit short selling. Fund managers can leverage this capability to profit from declining stock prices, creating opportunities even in bearish markets. It also allows managers to enter new long positions, which can boost returns.

  1. Risk management

Long-short funds provide a hedge against market downturns by profiting from short positions when stock prices fall. This capability helps mitigate the impact of adverse market movements, offering a layer of protection and reducing portfolio volatility during bear markets.

  1. Flexibility

Long-short strategies allow managers to adjust risk profiles based on market conditions. Unlike funds that are tied to a specific benchmark, these strategies allow for more dynamic and responsive decision-making.

Cons of investing in long-short AIFs

Despite the benefits, long-short AIFs also come with certain disadvantages that investors must consider.

  1. Market risk

As with any market investment, there is always a risk of losing money. Long-short AIFs are not immune to market risk, and investors can incur losses if the market moves unfavorably against both long and short positions.

  1. Risk of short-selling

Short-selling involves borrowing stocks, betting that the price of a stock will decline. When prices fall, the short seller buys the shares and books a profit. If the stock price rises instead, investors can face substantial losses. This risk is amplified in volatile markets where price movements are difficult to anticipate.

  1. Stock selection risk

The selection of stocks for buy or sell positions determines returns in the fund. Losses can also arise from issues unique to specific businesses, unrelated to general market trends. Factors such as management decisions, operational inefficiencies, or sector-specific problems can negatively impact the fund’s performance.

  1. High costs

These funds typically incur higher transaction costs, including borrowing fees for short selling. Higher management fees associated with the complexity of managing long and short positions can also reduce net returns, impacting overall profitability for investors.

Alternative Investment Funds Taxation in India

Since the strategy involves complex market models including leverage, the net return (post of all expenses) is fully taxable (at the maximum marginal rate) at the fund level.

Who should invest in AIFs? Assessing suitability for investors

Alternative investment funds are suitable for investors who seek higher returns and are willing to take higher risks. These funds are apt for high-net-worth individuals, family offices, and institutions with surplus money. Moreover, investors with experience in financial markets and an understanding of complex investment strategies may find AIFs more suitable.

AIFs have a high minimum investment amount and a long lock-in period. Thus, people who can invest for the long term without needing quick access to their money should consider them. Investors should also be comfortable with limited liquidity and market ups and downs.

In a nutshell, AIFs are meant for financially stable investors who want to diversify their portfolio by investing in instruments other than traditional investment options.

How to invest in alternative investment funds in India?

The steps you need to follow to invest in alternative investment funds in India are:

  • Check if you have the required funds to invest in AIFs, as the required minimum investment amount is high.
  • Arrange for the minimum investment amount, usually Rs. 1 crore or more.
  • Understand the different types of alternative investment funds – Category I, II, and III – and choose based on your risk level.
  • Research the SEBI-registered alternative investment funds list and study their past performance.
  • Read the offer document carefully to know the strategy, fees, and lock-in period.
  • Select a trusted fund manager with good experience.
  • Complete KYC and other required documentation.
  • Invest through the fund house or a registered distributor.
  • Track your investment regularly and stay updated on fund performance.

Checklist before investing in AIFs

Before investing in AIFs, investors should follow a simple checklist:

  • Confirm that the AIF is SEBI-registered.
  • Understand the investment strategy and risk level.
  • Check the minimum investment amount.
  • Review the lock-in period and liquidity terms.
  • Evaluate the fund manager’s experience and track record.
  • Read the fee structure and other charges carefully.
  • Ensure the investment matches your financial goals.
  • Invest only if you can stay invested for the long term.

Conclusion

Long-short AIFs can offer great opportunities for high returns through diversified strategies. However, they also come with risks like higher fees and market volatility. Investors should understand these factors and consider their risk tolerance. With careful consideration and professional advice, long-short AIFs can be a beneficial addition to their portfolio.

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FAQs

What is an alternative investment fund (AIF), and how does it work in India?

Investing in long-short alternative investment funds (AIFs), Category III funds, is gaining popularity among Indian investors who want to diversify their portfolios and better manage risks. These funds let managers take both long and short positions in different assets, offering a unique investment strategy that can lead to high returns. However, like all investments, Long-short AIFs have their pros and cons. This article will explain what long-short AIFs are and their benefits and drawbacks.

What is an alternative investment fund (AIF)?

Before switching your investments into a long-short AIF, it is essential to understand what an alternative investment fund is. An AIF is a type of investment fund that collects money from investors and invests it in areas other than the standard options, such as shares, bonds, or fixed deposits. Generally, AIFs invest in assets, including real estate, private companies, hedge funds, startups, and specific projects. Investors willing to take higher risks to earn higher returns should consider investing in AIFs.

AIFs differ from mutual funds as they adopt flexible investment strategies. Professional fund managers manage these funds, and their decisions are based on market opportunities. In many countries, AIFs are regulated by financial authorities to protect the investors’ interests.

AIFs demand a high minimum investment amount. This makes them the ideal choice for high-net-worth individuals and institutions. They also have a longer lock-in period, meaning you cannot withdraw money easily.

Types of alternative investment funds in India

In India, the Securities and Exchange Board of India (SEBI) classifies alternative investment funds into three main types. These categories are based on the type of investments they make and the associated risk.

  1. Category I AIFs: These funds invest in areas that support economic growth. Some common Category I AIFs are venture capital funds, social venture funds, startup funds, infrastructure funds, and SME funds. Since these funds focus on development, the government encourages the investment through tax benefits and relaxed investment rules.
  2. Category II AIFs: This AIF type invests in private equity funds, debt instruments, or other AIFs that do not fall under Category I or III. These funds usually have a medium level of risk and do not use heavy borrowing. They operate flexibly, but they must adhere to standard SEBI compliance.
  3. Category III AIFs: These funds use complex trading strategies and may invest in shares, derivatives, or hedge funds. They aim for short-term returns and carry a higher risk. As a result, they are suitable only for experienced and well-informed investors.

Overall, these three types help investors choose funds based on their risk and return goals.

Alternative investment funds list (Popular AIF examples in India)

Many popular AIFs in India attract high-net-worth investors. These funds invest in areas like private equity, real estate, startups, and hedge strategies. The following alternative investment funds list comprises names of different funds across the three categories:

  1. Category I AIFs invest in high-growth ventures and early-stage funds
    1. Negen Angel Fund
    2. Pipe Serica Angel Fund
    3. Finvolve Growth Opportunities Fund
    4. India Discovery Fund - II
  2. Category II AIFs invest in private equity and private credit strategies
    1. Singularity Investments Fund of Fund
    2. Unicorn India Ventures Fund
    3. Bharat Value Fund
    4. Nine Rivers Capital Aurum Rising India Fund
    5. 360 ONE Asset Early-Stage Fund
  3. Category III AIFs invest in listed equities using either long-only or long-short strategies
    1. Ampersand Growth Opportunities Fund
    2. Negen Undiscovered Value Fund
    3. Sameeksha Equity AIF
    4. ICICI Equity Opportunities AIF
    5. 360 ONE Equity Opportunity Fund

What is a long-short AIF?

Long-short AIFs are a type of hedge fund that involves taking long positions (buying securities expected to increase in value) and short positions (selling borrowed securities expected to decrease in value). The goal is to profit from rising and falling markets, providing potential for higher returns and risk management through diversification of market positions.

For example, an investor might identify Company A as undervalued and Company B as overvalued based on fundamental analysis. The investor would buy shares of Company A, expecting its stock price to rise (long position), and sell shares of Company B, anticipating a decline in its stock price (short position).

By balancing these positions, long-short strategies aim to generate returns regardless of the broader market trend.

Pros of investing in long-short AIFs

Investing in long-short AIFs offers several advantages that can improve an investor’s portfolio.

  1. Portfolio diversification

Unlike long-only strategies, a long/short investment strategy allows managers to buy stocks and bonds they expect to outperform the market while simultaneously shorting assets they predict will underperform. This approach broadens the investment opportunities, potentially creating a more diversified portfolio that is less tied to the fluctuations of traditional equity and fixed-income markets.

  1. Potential for excess returns

Long-short strategies can profit in rising and falling markets, which can result in higher returns. However, this approach also carries an increased risk of significant losses, particularly if both the long and short positions perform poorly.

  1. Short selling permitted

Unlike many mutual funds, where short selling is prohibited, long-short AIFs permit short selling. Fund managers can leverage this capability to profit from declining stock prices, creating opportunities even in bearish markets. It also allows managers to enter new long positions, which can boost returns.

  1. Risk management

Long-short funds provide a hedge against market downturns by profiting from short positions when stock prices fall. This capability helps mitigate the impact of adverse market movements, offering a layer of protection and reducing portfolio volatility during bear markets.

  1. Flexibility

Long-short strategies allow managers to adjust risk profiles based on market conditions. Unlike funds that are tied to a specific benchmark, these strategies allow for more dynamic and responsive decision-making.

Cons of investing in long-short AIFs

Despite the benefits, long-short AIFs also come with certain disadvantages that investors must consider.

  1. Market risk

As with any market investment, there is always a risk of losing money. Long-short AIFs are not immune to market risk, and investors can incur losses if the market moves unfavorably against both long and short positions.

  1. Risk of short-selling

Short-selling involves borrowing stocks, betting that the price of a stock will decline. When prices fall, the short seller buys the shares and books a profit. If the stock price rises instead, investors can face substantial losses. This risk is amplified in volatile markets where price movements are difficult to anticipate.

  1. Stock selection risk

The selection of stocks for buy or sell positions determines returns in the fund. Losses can also arise from issues unique to specific businesses, unrelated to general market trends. Factors such as management decisions, operational inefficiencies, or sector-specific problems can negatively impact the fund’s performance.

  1. High costs

These funds typically incur higher transaction costs, including borrowing fees for short selling. Higher management fees associated with the complexity of managing long and short positions can also reduce net returns, impacting overall profitability for investors.

Alternative Investment Funds Taxation in India

Since the strategy involves complex market models including leverage, the net return (post of all expenses) is fully taxable (at the maximum marginal rate) at the fund level.

Who should invest in AIFs? Assessing suitability for investors

Alternative investment funds are suitable for investors who seek higher returns and are willing to take higher risks. These funds are apt for high-net-worth individuals, family offices, and institutions with surplus money. Moreover, investors with experience in financial markets and an understanding of complex investment strategies may find AIFs more suitable.

AIFs have a high minimum investment amount and a long lock-in period. Thus, people who can invest for the long term without needing quick access to their money should consider them. Investors should also be comfortable with limited liquidity and market ups and downs.

In a nutshell, AIFs are meant for financially stable investors who want to diversify their portfolio by investing in instruments other than traditional investment options.

How to invest in alternative investment funds in India?

The steps you need to follow to invest in alternative investment funds in India are:

●      Check if you have the required funds to invest in AIFs, as the required minimum investment amount is high.

●      Arrange for the minimum investment amount, usually Rs. 1 crore or more.

●      Understand the different types of alternative investment funds - Category I, II, and III - and choose based on your risk level.

●      Research the SEBI-registered alternative investment funds list and study their past performance.

●      Read the offer document carefully to know the strategy, fees, and lock-in period.

●      Select a trusted fund manager with good experience.

●      Complete KYC and other required documentation.

●      Invest through the fund house or a registered distributor.

●      Track your investment regularly and stay updated on fund performance.

Checklist before investing in AIFs

Before investing in AIFs, investors should follow a simple checklist:

●      Confirm that the AIF is SEBI-registered.

●      Understand the investment strategy and risk level.

●      Check the minimum investment amount.

●      Review the lock-in period and liquidity terms.

●      Evaluate the fund manager’s experience and track record.

●      Read the fee structure and other charges carefully.

●      Ensure the investment matches your financial goals.

●      Invest only if you can stay invested for the long term.

Conclusion

Long-short AIFs can offer great opportunities for high returns through diversified strategies. However, they also come with risks like higher fees and market volatility. Investors should understand these factors and consider their risk tolerance. With careful consideration and professional advice, long-short AIFs can be a beneficial addition to their portfolio.

What are the main categories of alternative investment funds in India?

AIFs in India are divided into three types:

●      Category I for growth sectors

●      Category II for private equity and debt

●      Category III for trading strategies

How do long-short AIFs differ from other types of AIFs?

Long-short AIFs buy stocks expected to rise and sell stocks expected to fall. The aim is to earn returns in both rising and falling markets.

What are the risks of investing in alternative investment funds?

AIFs involve high risk, low liquidity, long lock-in periods, and market uncertainty. Thus, they are unsuitable for investors seeking quick or safe returns.

Who can invest in alternative investment funds in India?

AIFs are mainly for high-net-worth individuals, family offices, and institutions that can invest large amounts and stay invested for the long term.

Are returns from alternative investment funds taxable in India?

Yes, returns from AIFs are taxable in India. Taxation depends on the fund category and the type of income earned by investors.

How can I find a list of SEBI-registered AIFs in India?

You can find the official SEBI-registered alternative investment funds list on the SEBI website under the Alternative Investment Funds section.

What are the minimum investment requirements for AIFs in India?

The minimum investment for most alternative investment funds in India is Rs. 1 crore. It may be lower for employees or directors of the fund.

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