Hedge Funds in India
- 4 October 2020 | 192 Views | By Abhinav Mishra
Almost everyone knows about mutual funds and its different types. With mutual funds, you invest in equities and in bonds. In this article, we are going to talk about a different type of mutual fund – hedge funds. Hedge funds are still in their initial phase and not as popular as other mutual funds in India. Though they also pool investment from a number of investors, everyone is not eligible to invest in hedge funds.
What are Hedge Funds?
Hedge means to safeguard and in investing, it means to protect your investment against risks. So a hedge fund is one that protects investor’s investment from market risk. The investors in such funds are banks, High Net Worth Individuals (HNIs) and families, Insurance firms, and pension and endowments. Unlike mutual funds, hedge funds can invest in anything from currencies to real estate and other alternative assets. The aim and purpose of all hedge funds are to eliminate risk and maximize investor returns, irrespective of fact that the market is going down or up.
In India, all mutual funds are registered with SEBI but hedge funds are not registered with SEBI though they provide initial approval for the creation of hedge funds. Also, hedge fund houses are not obliged to disclose their NAV periodically.
What is the Investing Strategy of Hedge Funds?
Different funds can have different strategies to reduce the risk of their investors. For that, fund managers usually need aggressive management. These funds tend to employ substantial leverage. Returns in hedge funds are not governed by market conditions but by the fund manager’s skill. Some of the strategies that fund managers follow are:
Use of arbitrage – Arbitrage, in finance, is the practice of taking advantage of a price difference between two or more markets. Fund managers use this to their advantage. Fund managers can use this for buying and selling two very highly correlated securities simultaneously to book profit when markets are moving sideways. This is called relative value arbitrage.
Sell short – The managers hoping for the prices to drop can sell shares to buy-back in the future at a lesser price. In traditional mutual funds, fund managers never short shares.
Upcoming events – Some major market events like mergers, acquisitions, and spin-offs among others can influence the manager’s investment decisions.
What are the Features of Hedge Funds?
Below are some features of hedge funds:
Only accredited or qualified investors can invest in hedge funds. Retail investors are not allowed to be part of hedge funds. One reason for this is that it is a high-risk fund.
Hedge funds come with two types of fees – expense ratio and management fees. The global standard for these fees is ‘Two and Twenty’ meaning the fund house will charge fixed fees of 2% and 20% of profits. In India, the numbers are comparatively lower for both fixed fees and profit percentages. The fixed charges can be between 1 and 2% while management fees can be 10 to 15%.
The investors have diversified portfolios from currencies, derivatives, stocks, real estates, equities, and bonds.
Are hedge funds high risk?
Risk – Hedge funds are high-risk investments. Since the fund managers use leverage, your investment can suffer huge losses and hence they come with a long lock-in period.
What is the minimum to invest in a hedge fund?
In India, the minimum ticket size for investors is Rs 1 crore to invest in hedge funds while in the US, the minimum ticket size is $1 million. The ticket size varies from country to country.
What is the most successful hedge fund in the world?
Hedge funds are more about the individual fund manager who manages the show than market conditions. The most successful hedge fund house of all time is TCI Fund Management. TCI Fund Management generated a net gain of $8.4 billion last year. TCI Fund Management gained 41% last year. To understand how good it is you can compare it with industry peers. The average hedge fund return last year was 10%, even if you compare the S&P 500 which posted a total return of 31% last year, the TCI Fund Management stands out.
The biggest hedge fund in the world in terms of size is Bridgewater Associates, it manages about $160 billion in investor money.
What is a hedge fund example?
If you are interested in starting your hedge funds company, you can do that. Let us see how it will work. You can register a company as ‘Indian Investors Pvt. Ltd.’ or any name of your choice. To start with you need to sign an operating agreement with your investors. The agreements state how much profit you and investors will share. Let us say, you state that you will receive 20% of any profits over 2% per year. Once the investment amounts start coming in you can invest in stocks, real estate, startups, collectibles, gold, etc. 2% is your profit barrier. You must first cross this before profits start flowing in for you.
Let us say, an investor puts $10 million into your hedge funds. Now you put this money to use and in a year the company’s assets doubled to $20 million. The first 2% belong to investors from the profit of $10 million i.e $200K. The remaining $9.8 million will split – 20% to you and 80% to your investor.
The terms of the agreement can vary and there are no hard and fast guidelines to it.
Are there any hedge funds in India?
Yes, there are a lot of hedge funds available in India. However, investment in hedge funds is not so popular in India. The hedge funds got a go-ahead flag from the Securities and Exchange Board of India (SEBI) when they allowed Alternative Investment Funds (AIF) in 2012. At present, there are 346 AIFs registered with SEBI. Some of the top hedge funds in India are The Mayur Hedge Fund, India Insight value fund, Multi-Act Equity Research Services Pvt Ltd, TresVista Financial Services Pvt Ltd, Malabar India Fund LP, Forefront Capital Management Pvt Ltd, etc.
Can anybody start a hedge fund?
Yes, if you fulfill all the basic requirements you can start your own hedge fund. However, implementing risk controls, hiring staff, growing assets, and running the organization as a profitable business while producing positive performance is very challenging. If you need to start your hedge fund firm in India, you need to take permission from SEBI with an application fee of Rs 1 lakh and a registration fee of Rs 5 lakh. There are three categories in which you can seek registration from SEBI, category III is for hedge funds which state that –
Alternative Investment Funds such as hedge funds that are formed and traded with a view to make short term returns or such other funds which are open-ended and for which no specific concessions or incentives are given by other regulators or the government.
Is it hard to start a hedge fund?
It is very difficult to start a Hedge Fund in India because of the guidelines enforced by SEBI. If you do a bit of research on the working of Hedge funds in India, you will see the guidelines by SEBI make it impossible to start one. One major highlight would be that your fund’s value should be more than 20 crores and it can only serve 20 clients at maximum.
How are hedge funds taxed in India?
Hedge funds fall under category III AIF and are taxed according to taxation rules that are applicable to AIF category III. Under this category, the fund, on the whole, has to pay a tax when it realizes gains or gets income in any form. The taxation is at the fund level and the tax obligation is not passed through to the unit holders or its investors. In other words, the taxes are withheld before the profits are distributed to you. This is one of the main reasons why these are not so popular in India.
Will hedge funds exist in 10 years?
Having discussed so much about the hedge funds, we can say the industry is still evolving and still finding ways to reach more people. Hedge funds will surely be around in 10 years but will be more organized and consolidated with easier access to smaller investors and lower fees.