It is important, at this juncture, to understand the primary options available to these investors and how they differ structurally.
By: Nikhil Kamath
The fact that India is one of the world’s fastest growing trillion-dollar economies is well-known. With an advantageous demographic trend, positive long-term economic potential and increasing levels of income, the Indian wealth management industry is on a steady, upward trajectory.
India is also known for its general inequality in wealth, with a large concentration amongst the top few percent. Interestingly, in 2017, India was the fastest growing market globally, with a 20.4% HNI (individuals with an investable surplus of $1 million or more) population expansion and 21.6% HNI wealth growth. It is important, at this juncture, to understand the primary options available to these investors and how they differ structurally.
A mutual fund is a pooled investment vehicle, with capital collected from many investors. Mutual funds invest in a variety of securities including equity, bonds and money market instruments. Mutual funds are managed by professionals that set an allocation and generate returns according to the fund’s objectives.
Naturally, mutual funds are a popular choice amongst investors due to their convenience, advanced portfolio management and diversification of risk. The minimum capital required to invest in a mutual fund is also significantly small, and this makes it a lucrative option for people that are looking to invest a certain portion of their surplus capital on a regular basis.
However, high expense ratios, management and sales charges could prove to be inefficient. In addition, due to turnover, churn, redemptions, profits and losses, investors generally have no control over capital gains pay-outs.
Portfolio Management Services (PMS)
A portfolio management service (PMS) is an investment portfolio in equity, fixed income instruments, structured products, and other individual securities. PMS can either be discretionary or non-discretionary, with the former having the Portfolio Manager in charge of all decisions, and the latter leaving room for individual investors to voice their preferences. The execution right, however, lies with the Portfolio Manager in both cases.
PMS are geared more towards individuals or institutions that have a higher investable surplus as the SEBI-mandated minimum investment is 50 lakhs. PMS also offer advanced portfolio management along with the benefits of flexibility, risk diversification, and more customized service. In terms of tax liability, an individual investing with a PMS would be taxed in the same way had they invested in the capital markets directly. However, inefficiencies arise when management fees and performance charges are high.
Alternative Investment Funds (AIFs)
An Alternative Investment Fund (AIF) is an investment vehicle that sets itself apart from conventional securities such as stocks, debt, or other money market instruments. AIFs are classified into three different categories:
- Category I
A Cat-I AIF invests in start-ups, small and mid-sized enterprises (SMEs) and projects that are defined to be economically and socially viable.
Venture Capital (VC) Funds, Infrastructure Funds, Angel Funds, Social Venture Funds are all examples of this category of an AIF. The minimum investment for all these types of funds is 1 crore, except for an Angel Fund, that has a mandated minimum of 25 lakh.
- Category II
A Cat-II AIF invests in several equity and debt securities. All the funds that aren’t included under the Cat-I and Cat-III definitions fall under Cat-II.
Private Equity (PE) Funds, Debt Funds, and Fund of Funds are included in this category of AIFs.
- Category III
A Cat-III AIF aims at generating short-term returns by executing several diverse, complex trading strategies. Cat-III AIFs are usually synonymous with hedge funds but can also include Private Investment in Public Equity (PIPE) Funds. Funds can either be long-only, focused entirely on equity, or long-short, where derivative strategies can be employed as well.
AIFs are high-risk, high-reward investment vehicles, and are suited to more sophisticated, market-savvy investors, with a minimum SEBI-mandated investment minimum of 1 crore. Cat-III AIFs are the only pooled investment vehicles in India that are legally permitted to take short positions, giving this structure a one-up over a mutual fund or a PMS, where profitability is unidirectional.
A Paradigm Shift
According to Capgemini’s World Wealth Report 2020, all the COVID-induced volatility and unpredictability has accelerated, amongst other things, the realization among HNIs that the fees they pay their wealth managers are too high. A staggering 33% of HNIs globally are uncomfortable with their fees, and this served as the primary cause for switching to a new firm or wealth management service. An increasing number of HNIs are now looking for performance or service-based charges as compared to being content with upfront management fees. It is imperative for the growth of the Indian wealth management industry to focus more on the client journey, transparency with reporting processes and procedures, leverage technology such as artificial intelligence and machine learning to customize advisory and service offerings, create strategic value, and do away with heavy, traditional fee structures.
(Nikhil Kamath is the Co-founder and CIO, True Beacon and co-founder of discount brokerage Zerodha. The views expressed are the author’s own. Financial Express Online does not bear any responsibility for investment advice in this column. Please consult your investment advisor before investing.)