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    Debt AIFs ready for a big leap with the new lease of life from regulators

    Synopsis

    SEBI's regulatory changes aim to bring transparency to the Alternative Investment Fund (AIF) industry and instill confidence in both fund managers and investors. A key change allows investor participation in AIFs via a direct plan, which avoids upfront payment of distributor commission and lowers costs for investors. Mandatory dematerialisation of AIF units aims to ensure transferability and liquidity. The Finance Act 2023 brings tax parity across all debt products, making incremental investment in debt MFs post-April 1, 2023, subject to long-term capital gains tax. With indexation benefits no longer available, high-performing credit AIF strategies offer high-yielding returns to investors.

    Debt AIFs ready for a big leap with the new lease of life from regulators
    2023 began with reforms that gave a new lease of life to the Alternative Investment Fund (AIF) industry. The AIF industry ought to receive the desired attention from regulators, given the stupendous growth in AIF commitments over the past decade since the first AIF regulations were put into place.

    The commitments raised by the AIF industry touched nearly Rs 7 lakh crores (as of June 2022). The recent spate of regulatory changes by SEBI is a welcome step for the sustainable long-term growth of the AIF industry.

    On a separate note, a game-changer event for debt AIFs and a surprise move came from the finance minister. Debt AIFs got the much-awaited level-playing field in the taxation of debt investment products as the new Finance Act 2023 brought tax parity across all debt products.

    SEBI’s recent Regulations – A Step in the Right Direction
    The recent regulatory changes by SEBI aim to bring fairness and transparency to investors in AIFs. A transparent regulatory regime instills confidence in both fund managers and investors of fund schemes.

    Amongst the changes, a key change that allows investor participation in AIFs via direct plan’ and restricts upfront payment of distributor commission to 1/3 rd of the total distribution fee for Debt AIFs (Cat I and Cat II AIFs) is effective from May 1, 2023.

    Similar practices were implemented in the MF industry a decade back and for PMS schemes in 2020. The direct plan entails no distribution or placement fee and lowers the cost to investors, and avoids chances of miss-selling.

    While transparency is one aspect to develop the AIF market, SEBI is keen on ensuring transferability and liquidity by making the dematerialisation of AIF units mandatory.

    The Sebi board amended AIF regulations at the end of March, mandating new AIF schemes and existing AIF schemes with a corpus of more than Rs 500 crore to dematerialise their units by October 31, 2023, while existing schemes with a corpus of less than Rs 500 crore need to dematerialise their units by April 30, 2024.

    It is a crucial step that can promote AIF products and create accessibility to the larger market.

    The next logical step in this regard would be listing units which will allow better price discovery and digitise the trading and settlement process, which is currently offline.

    Finance Act 2023
    The Finance Act 2023 provided the long-awaited level playing field to all debt asset managers of various pooled investment vehicles (MFs, PMS, AIFs). The Act puts an end to the long-term capital gains tax rate of 20% along with indexation benefits (applicable for a holding period of more than three years) for incremental investment in debt MFs post 1 st April 2023.

    This makes the post-tax return comparison redundant, and the appropriate metrics move now to net return to investors on a pre-tax but post management fees, expenses (set up cost, operating cost), and carry/performance fee, which will depend on the quality or risk of underlying investments, total expense ratios and carry the structure of the funds.

    Investors were so far attracted to debt MFs due to the relatively safer assets in addition to the benefit of indexation, which was enjoyed by nearly Rs 13 lakh crore debt MF industry.

    As the indexation benefit is no longer available for incremental debt MF investments and given the higher spread between A and below-rated assets vis-à-vis AA and above instruments, investors with adequate risk appetite will look for well-managed performing credit AIF strategies, which offer high-yielding returns as compared to AAA focused debt MFs.

    Without changing the risk profile, the alpha for performing credit AIFs over Bond ETFs ranges between 600-700 bps on a pre-tax basis, while the same stood at 110-165 bps on a post-tax basis (for investors in the highest tax bracket) before the Finance Act 2023.

    The tax change is a welcome move for asset managers in debt AIFs space as investors can now decide the portfolio allocation purely based on the risk-reward spectrum and asset manager’s track record rather than post-tax returns, which wasn’t much under the control of the asset manager per se.

    However, going forward, investors will need to be vigilant in their evaluation of asset managers and should prefer the ones with established track records with consistent investment strategies across periods.

    Further, the categorisation of AIFs becomes important as the risk-rewards of AIFs investing in operating entities rated ‘A’ or up to investment grade could be materially different from AIFs investing in venture debt, distressed, structured credit, or real estate.

    (Dipen Ruparelia is head - products at Vivriti Asset Management)

    (Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)



    (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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