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