ALTERNATIVE INVESTMENTS

Presented by –
Mr. Archit Lohia
CA, CFA, CAIA, LLB

Copyright 2019, CareerTopper.com. All rights reserved.

WHAT ARE ALTERNATIVE INVESTMENTS?

Alternative
Investments

2
 WHAT MAKES ALTERNATIVE ASSETS
DIFFERENT FROM TRADITIONAL ASSETS?

1. Rarity
2. Scarcity

3
 AVERAGE TIME-TAKEN TO BECOME A UNICORN

• Between 2011 and 2015, the industry saw a rapidly evolving start-up environment
with expansion and scaling of first generation start-ups.
• This was followed by a phase of maturity and moderation between 2015 and 2017. In
2019, the time to unicorn has reduced to just two years!
 GROUP DISCUSSION

• Group 1: No. of startups and Unicorns in India – Out of that how many are primarily B2B and B2C
• Group 2: Unicorns – Top 3 PE Funds present in as investors in Unicorns and their major holdings
• Group 3: Unicorns – Industry-wise, City-wise breakup and Average Time Taken to Unicorn
• Group 4: Founders of Unicorns – Education Qualifications, Gender Ratio and Median Age
• Group 5: Unicorns – Breakup of funding rounds – Angel to IPO
ALTERNATIVE INVESTMENT TYPES –
PRIVATE EQUITY

• Provides equity financing to start-ups without any track record

Venture or business size.
• Venture-capitalists take senior equity stakes in the high-risk,
Capital illiquid and unproven business ideas of the promoters
(VC) • Intent is to generate large profits through the success of the
businesses, which go public, through sale or an IPO.

• In an LBO, the equity of a public company is purchased using a

small amount of investor capital and a large amount of debt,
Leveraged secured by the assets of the company.
Buyout • This is done to exploit tax advantages, improving operating
efficiency and profitability and take the company public again.
(LBO) • Cash flow generated from the firm is used to service the debt
taken to invest.

6
LEVERAGED BUYOUT –
TOP SUCCESSFUL INDIAN DEALS

2019 Deals:

• Baring Private Equity Asia signed a $360 million loan backing the purchase of a stake in
NIIT Technologies (Holds 56% stake)

• Blackstone Group signed a $166 million LBO loan facility for financing the acquisition
of Essel Propack Ltd. (Holds 51% stake)

INDIAN COMPANY TARGET COMPANY COUNTRY VALUE

(MILLION $)
TATA TEA TETLEY UNITED KINGDOM 271
UB GROUP WHYTE & MACKAY UNITED KINGDOM 550
TATA STEEL CORUS HANSEN UNITED KINGDOM 11300
SUZLON ENERGY TRANSMISSIONS NETHERLANDS 465
TATA MOTORS AMERICAN AXLE UNITED STATES 2000

7
LEVERAGED BUYOUT –
TOP SUCCESSFUL INDIAN DEALS

8
LEVERAGED BUYOUT – FORMS

• Public to Private Deals may be Friendly or Hostile.

• Friendly cases typically involve the management buying the
Public to company, to operate it thereafter as a privately-held entity.
(commonly known as “Management Buyout”)
Private • Hostile cases involve an investor or investor group, who intent
on buying, reorganizing, and then reselling the company again
to realize a high return.

• When one element/segment of the business is sold in the

Spin-offs transaction, to one or more investors, it is called a spin-off.

Private • Privately held operations is bought by an investor group.

• This situation occurs in cases of small business owners, who do
Deals not find corporate buyers, hence employees of the firm invest.

9
PRIVATE CAPITAL – DEBT FORMS

• Form of debt which provides the option to investors to convert

their debt to equity, at a later stage.
Mezzanine
Debt • It covers risky claims such as Preferred Stock, Convertible Debt,
Debt.

• Debt of companies that have filed or are likely to file for

bankruptcy protection.
Distressed
Debt • Distressed Debt carries high risk, on account of uncertain
future cash flows, hence they are treated as Private Equity.

10
PRIVATE CAPITAL – DEBT FORMS

HOW IS DISTRESSED DEBT DIFFERENT

FROM ASSET RECONSTRUCTION
COMPANIES (ARCs)

11
 GROUP DISCUSSION

• Group 1: No. of startups and Unicorns in India – Out of that how many are primarily B2B and B2C
• Group 2: Unicorns – Top 3 PE Funds present in as investors in Unicorns and their major holdings
• Group 3: Unicorns – Industry-wise, City-wise breakup and Average Time Taken to Unicorn
• Group 4: Founders of Unicorns – Education Qualifications, Gender Ratio and Median Age
• Group 5: Unicorns – Breakup of funding rounds – Angel to IPO
POST COVID-19 ERA – WHAT’s IN IT FOR YOU?

Based on global financial crisis (GFC) experience, deals invested during or after a
downturn tend to do well. The market disruption caused by Covid-19 will likely lead to
growth in select pockets (e-commerce, enterprise technology/SaaS, healthcare, on-
demand services) and create investment opportunities.

Choose Companies which follow: DILIGENCE

D - Demand
I - Investment-driven
L - Leaders in market
I - Innovative business models
G - Government support
E - Essential goods
N - No substitutes
C - Compliant
E - Enough flexibility
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ALTERNATIVE INVESTMENTS –
OTHER INVESTMENTS – ART & PAINTINGS

Sold for $ 120 Million

Sold for $ 142.20 Million

Source: Artprice
https://www.artprice.com/artmarketinsight/the-artprice100-index-of-blue-chip-artists-up-3-over-2022

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 ALTERNATIVE INVESTMENTS –
OTHER INVESTMENTS – ART & PAINTINGS

Source: CAIA
https://caia.org/blog/2021/07/22/investing-art-market-17-trillion-asset-class
15
ALTERNATIVE INVESTMENTS –
OTHER INVESTMENTS – WINE

Comparison of Returns

Nifty

FTSE 100

S&P 500

Gold(USD)

Liv-ex fine wine investables

Liv-ex fine wine 50

Live-ex bordeaux 500

Live-ex fine wine 100

Liv-ex fine wine 1000

-20.0% -10.0% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

5 YR 2 YR 1YR MOM

Source: Liv-ex December Market Report and Statista 16

ALTERNATIVE INVESTMENTS –
OTHER INVESTMENTS – FILMS

Source: ImDB and multiple sources 17

ALTERNATIVE INVESTMENTS –
OTHER INVESTMENTS – SPORTS

Source: TreeLife

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• What is a Hedge Fund?
• How are Hedge Funds different from PMS?
• How are Hedge Funds different from Mutual Funds?
• Would you prefer a Mutual Fund, Hedge Fund or
PMS to invest in?

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WHAT ARE HEDGE FUNDS?
Characteristics of Hedge Funds

Active Management using a number of investment strategies

• HFs can use leverage, derivatives and take short positions. Hence it has more Flexibility
than the traditional investments.

Hedge Funds are set-up as Private Investment Vehicles in the form of Limited
Partnerships
• Investors are Limited Partners, with Limited liability in the partnership.
• HFs include accredited investors only. Such investors have sufficient Net Worth and
Liquidity to invest their funds in HFs and have it locked-in for certain amount of time.
• The Management Firm/Manager is the General Partner who manages the Fund.

Low Regulations and Transparency

• Less Regulated as compared to Traditional Investments

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HEDGE FUND DATA – PERFORMANCE
DURING GFC

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CTA AND MANAGED FUTURES
A Commodity Trading advisor (CTA) is an individual or firm who provides advice regarding
the buying and selling of futures contracts and options on futures in commodities.
CTA’s require a Commodity Trading Advisor (CTA) Registration, as mandated by the National
Futures Association (NFA), USA.
Managed Futures refers to active trading and managing risk of futures and/or forwards on
physical commodities and/or financial assets to enhance returns and diversification.

Systematic Trading Systems

Energy
Metal
Equity Indices
Interest Rates
Agriculturals
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Currencies
STRUCTURED PRODUCTS

Why are Structured Products different?

 Structured Products exhibit a particular risk-return attribute, as desired by the investor.

 Structured Products are normally created by (a) the partitioning of the cash flows of a
traditional investment, or (b) by linking the returns of the product to the market value of
the traditional asset

 Examples:
o Debt Securities v/s Equity Securities: An Organization’s cash flows are split into less
risky cash flow (debt) and highly risky cash flow (equity)

o Collateralized Debt Obligations (CDOs): CDOs partition the synthetic returns from a
portfolio into securities with varied levels of risk (a.k.a. Tranches)

o Credit Derivatives: These products help in transferring credit risk, as credit risk
associated with a specific exposure can be transferred from the credit protection
buyer to the credit protection seller

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STRUCTURED PRODUCTS - SDIs and ASSET FINANCING

What are Securitized Debt Instruments?

Assign
Leasee Receivables Monthly
Company Payments

Asset Pool of Assets

Cars: Leased
Investors
50 crore
SDI Issuer
Cash
Ex: Everest Principal: 50 crore
Fleet IRR: 15-25%
Tenure: More than 3
Internal Credit Enhancement years
and Rating given by CRISIL Min. Amount: Rs. 1 lakh
Credit Rating: BBB

Ex: GRIP Invest

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 STRUCTURED PRODUCTS - CDO

Principal:
$100 million
Payments:
Bond Interest + Principal Senior Tranche
Portfolio
Principal: $75 million
Return: 4%
Assign Credit Rating: AAA
Investment
Originator Receivables

Asset Pool: Cash

Issue Notes Junior Tranche
$100 million Special
Principal: $20 million
Purpose
Cash Return: 8%
Vehicle Credit Rating: BBB

SPV gets Credit Enhancement

and Liquidity Support Equity Tranche

Principal: $5 million
Return: 15%
Credit Rating: None
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STRUCTURED PRODUCTS - CDS
Types of Credit Derivatives – Credit Default Swaps
 An insurance-like bilateral contract, in which the buyer pays periodic fees to the
protection seller, in exchange for a contingent payment from the seller if a credit event
(default) occurs at an underlying credit risky asset.

Credit Default Swap Total Return Swap

Reference Entity Reference Entity

Cash Cash
Total Return Total Return
Investment Investment

Credit Protection Buyer Credit Protection Buyer

Cash, in case of Total Return

Swap Premium Fixed Return
Credit Event

Credit Protection Seller Credit Protection Seller

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REIT STRUCTURE

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ALTERNATIVE INVESTMENTS vs TRADITIONAL INVESTMENTS

Alternative Investments Assets often considered as Assets Considered as

Traditional or Alternative Traditional Investments
Private Equity & Venture Illiquid & Closed-ended Publicly-traded Equities –
Capital Mutual Funds, used for side- generally Micro-cap, Small-
pocketing cap
Hedge Funds Liquid funds, involved in Mutual Funds
derivatives, short-selling
Commodity Derivatives Assets used for hedging. Buying and selling
Commodity Futures/Options commodities, like gold
Credit Derivatives, like Assets used for hedging. Insurance or Guarantee
Credit Default Swaps/CDOs Interest Rate Swap/FX contracts, on defaults
Swap/Cross-Currency Swap
Real Estate, REIT, InvIT Mortgage-backed securities, Purchasing Land, Mortgaged
Real-estate funds land

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ALTERNATIVE INVESTMENTS – MARKET PARTICIPANTS

Fund Buy-side Sell-side Service

Constituents Institutions Institutions Providers

Investment Fund
Sponsor Family Office
Banks Administrator

Sovereign Broker, Broker- Platform and

Investors
Wealth Fund dealer and Infrastructure
Clearing
Member
Distributors &
Endowment /
Fund Manager Third-party
Foundation
Consultants

Investee Alternative
Company / Legal Counsels
Investment
and Auditors
SPV Fund

Separately
Custodians,
Trustee Managed
RTAs and Banks
Accounts

Regulator – SEBI

SROs – Exchanges, Clearing Corporations

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MARKET PARTICIPANTS
Fund Constituents
• Sponsor sets up the Alternative Investment Fund. Sponsor is required to have
Sponsor necessary “skin-in-the-game” and be responsible for the operations of the Fund.

Investors • Institutional Investors and High net-worth Individuals

Fund • Typically an Asset Management Company appointed by the Alternative

Managers Investment Fund to manage its investments

• A start-up, SME, listed or unlisted company, special purpose vehicle or limited

Investee liability partnership, real estate investment trust, infrastructure investment
Companies trust in which an Alternative Investment Fund makes an investment.

• Trustee holds the assets in the Fund on behalf of the investors and takes on the
Trustee fiduciary duty to safeguard the assets and ensure the Fund works for the best
interest of the Investors.

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MARKET PARTICIPANTS
Buy-side
• Private Wealth Management firms serving ultra-high net-worth individual investors.
Family • A group of investors, generally related parties or a Family, who manage their
Office personal investments as a single entity outsource the investment management
activities to a financial management firm.

• Foundations are Non-profit fund established for charitable purposes. The corpus of
Foundation the fund is invested and Donations are made from those returns.
and • Endowments are set-up by museums, universities, hospitals, for specific purposes.
Endowment (e.g. University Student Programs). Corpus is invested accordingly.

• Foreign Alternative Investment Funds such as Hedge Funds, Private Equity Funds,
AIFs and
Fund-of-Funds invest in Indian Alternative Investments and investee companies.
Separately • Separately Managed Accounts (SMAs) are individual investment accounts, owned
Managed by an investor and managed by an independent investment management firm.
Accounts The investments are managed in accordance with the particular client’s needs

Sovereign • Investment funds, held by the government, managed by the country’s Central
Wealth Bank for future return on investment and managing currency stabilization.
• These funds arise from tax/budget surpluses or export of natural resources.
Funds
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MARKET PARTICIPANTS
SMA vs Mutual Fund

PARTICULARS SMA MUTUAL FUND

Direct Stake: Investor directly owns the underlying Investor owns a stake in a fund, instead
securities in the portfolio. of a stake in the underlying securities.
Investment Investment Objectives can be There are pre-defined investment
Objectives: designed as per the requirements of objectives.
the investor.
Transparency: Provides greater transparency to the There are no details of individual
investor, with complete information holdings.
on all position in individual
securities.
Withdrawals: Not affected from the withdrawals of Mutual Fund AUM is affected, hence the
other investors. ROI also gets affected.
Limited Liability: SMA lacks the benefit of limited Mutual Funds offer the benefit of
liability offered by funds. Limited Liability.

32
MARKET PARTICIPANTS
Sell-side

• Large Dealer Banks, such as Goldman Sachs, Barclays, Deutsche Bank, etc., are
commercial banks which deal in securities and derivatives.
• These banks act as intermediaries in the markets for securities, repurchase
agreements, securities lending, and over-the-counter (OTC) derivatives.
• The activities at the banks are important, as they play a central role in the
economic system. Hence, presence of such banks is systemic risk to the
Investment market
Banks • Large Banks have asset management division and proprietary trading
division.
• They also provide off-balance sheet financing, account management services,
act as prime brokers, provide personal and corporate loans and manage
depository accounts. They also run own funds, both hedge funds and PE
funds.

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MARKET PARTICIPANTS
Sell-side

• Brokerage Houses, like Motilal Oswal, Prabhudas Liladhar, provide

investment recommendations through their research departments and
execute buy, sell or limit orders of clients, for a commission.
• Brokers, who are clearing members, act as middlemen and help their client
to clear and settle their trades through the exchange clearing system.
Identification of the client is kept anonymous.
• Brokers help traders by executing block deals or large orders in parts by
Brokers taking the contra side. Brokers also engage in Proprietary Trading.
• All large brokers play the role of dealers as well, to become a counter-party
for a large buy-sell order of a Fund and offer Best Execution.
• Departments within a Broker’s office:
• Front Office: Meeting with clients. Deciding which securities to buy and sell
• Middle Office: Risk Management and link between front and back office.
• Back Office: Accounting, Technology Upgradation, Clearing and Settlement.

34
MARKET PARTICIPANTS
Service Providers

Fund Administrators
• Administrator is responsible for verifying operations, assets and performance of funds.
• Administrators act as a third-party source to take care of day-to-day book-keeping and
third-party information gathering for funds, so that managers focus on core activities.
• Administrator is also helpful for auditors, as a source of information, in tax planning.
• Hedge Fund Administrators have been set-up across India, as service providers and also
setting base in the International Financial Services Centre (IFSC) in Gujarat.

Distributors and Third-party Consultants

• Distributors are important in not only the selling function but in the creation of wider
awareness and familiarity among the investor community with regard to AIFs
• Hedge Funds use services of domestic Investment Advisors and Due Diligence experts
to get the best output in the domestic market in which they are investing.
• Private Equity Investments also use services of Investment Advisors to help identify
potential investee companies.
• Apart from advisors, Startup Ecosystem also uses services of Startup Accelerators who
engage subject matter experts and mentors to help startups scale and grow.

35
MARKET PARTICIPANTS
Service Providers

Fund Infrastructure and Platform

Platform: Operating systems through which the fund manager can access internal and
external data pertaining to portfolio positions, risk analysis, client accounts, their profit and
loss and market data. This data is necessary for further strategy planning.

Software: These are open-source or proprietary programs used by the funds, working on a
particular Platform. They also provide the necessary research for strategy planning.

Data Providers: They supply date on security prices, trading information and indices, giving
fund performance. Normally, funds are not allowed to advertise and solicit clients. Hence,
if a fund’s performance is good, it will share its data with such data providers, as they
benefit from indirect marketing of fund performance to potential clients.

Many US-based Hedge Funds have out-sourced these functions and have their operations
in Indian cities like Gurugram, Hyderabad, and Ahmedabad. Certain independent firms
have also started operations which provide services to US-based funds.

36
MARKET PARTICIPANTS
Service Providers

Legal Counsels and Auditors

Legal Counsels provide legal advice to help the fund determine it’s the best legal structure,
investment strategies, objectives and investors. They help in preparation and filing of
documents for registration of a fund with the appropriate regulatory authority.
• Private-placement Memorandum/Offer Documents: Provided to potential investors,
explaining the investment strategies of the fund, its associated risks and whether it is in
compliance with the applicable regulations.
• Partnership Agreement: Formal contract, with the terms of the partnership, to be
signed by the Sponsor (General Partner) and Investors (Limited Partners)
• Term Sheet: The initial MoU between a Startup and a potential investor, showing
investor’s interest of taking a stake in the company, with certain binding and non-
binding clauses
• Share Subscription Agreement and Share Holder Agreement: Application submitted by
investors wanting to join a limited partnership and documenting the formal agreement
after conducting necessary Due Diligence
Auditors review the accounting issues and all documentation for a fund. They also provide
tax advice for the investment transactions. They also certify and assist in preparation and
filing of disclosures to be made to the investors and certify the financial statements and tax
statements filed with regulatory authorities. 37
MARKET PARTICIPANTS
Service Providers

Custodians, RTAs and Banks

Custodians are responsible for holding client’s securities and clearing and settlement of
the trades. They also provide information services on their client activity. As per SEBI
Regulations, some AIFs have to mandatorily appoint a registered Custodian with SEBI to
hold securities of their clients and ensure clearing and settlement. Funds with a minimum
corpus of Rs. 500 crores or a Fund set up as a Hedge Fund have to meet these
requirements.

Registrar and Transfer Agents (RTAs) are responsible to oversee the functions such as the
transfer of units, issue of new class of units, full and partial redemption calls, payment of
exit load, expenses and fees by the selling unit holder

Banks help in providing the additional leverage required, typically by Hedge Funds, to
facilitate their working capital, long-term capital management, loans, line of credit and
external credit enhancement.

38
 ALTERNATIVE INVESTMENT FUNDS –
STRUCTURE
Domestic /
Offshore
Investors
Investment
Investment
Contribution
Management
Sponsor Company
Sponsor Contribution

Trust Deed
Trustee AIF
Company (SEBI Investment Management
Management Fees and Carried
Service Registrati Agreement Interest
Providers on)
• Fund Administrators
• Custodians
• Registrar and Transfer
Agents Investe Investe Investe
• Accountants and e Co. 1 e Co. 2 e Co. 3
Advisors
• Auditors and Legal
Professionals
ALTERNATIVE INVESTMENT FUNDS –
UNIFIED STRUCTURE
Investment
Management Offshore Fund
Offshore
Fund Manager
Fees and Carry
Cross-border

India Investment Automatic

Sponsor Contribution Route Onshore Fund
Sponsor Contribution
Manager
Trustee Trust Deed Investment Management
Company Management Fees and
Services Carried Interest
Onshore Investment Subscription AIF
Investors
Service
Providers
Investee Investee Investee
Co. 1 Co. 2 Co. 3

40
ALTERNATIVE INVESTMENT FUNDS –
CO-INVESTMENT STRUCTURE
Investment
Management Offshore Fund
Offshore
Fund Manager
Fees and Carry
Cross-border

Co-Investment Investment Advisory Arrangement

India Arrangement
Onshore Fund
Manager
Sponsor Contribution Investment
Sponsor Investment Management
Trust Contribution
Management Fees and
Trustee Company Deed Services Carried Interest
AIF
Onshore Investors

Service Providers
Investee Investee Investee
Co. 1 Co. 2 Co. 3

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 GROUP DISCUSSION

• Group 1: Discuss the role of a Family Office Advisor and the top Family Offices in Asia.
• Group 2: Like Keiretsu Forum, discuss names of top Start-up Accelerators and Investment
Networks, in India and Globally
• Group 3: Which are the top Film Funds and Art Funds, in India? Are there any Wine Funds in
India? Make a global comparison
• Group 4: Discuss the viability of investments in Sports, and compare the returns on Leagues,
such as IPL, NFL, NBA, EPL, etc. Which investor class is most suited for this investment
• Group 5: Give names of entities which act as CDS Sellers in India. What are the kinds of CDS
Spreads in the Market, for different underlying assets?
FUND-CYCLE

QUIZ – WHAT IS THE TYPICAL LIFE-CYCLE OF THE FUND?

SEBI In-Principal
Approval

Fund Final
First
Set-up & Close
Close
SEBI
Intimation

Extension
Max 12 Exit Period of max. 2
months years
Investment Period

Fund Tenure
43
FEE STRUCTURE
Hedge Fund Fees

Management Incentive
Fees Fees

 Paid as a Percentage of Gross NAV,  Paid as a Percentage of profits

irrespective of the Fund making earned by the Fund.
profits or losses. Not based on
Committed Capital and Capital  Generally up to 20%
Contributions
 Incentive Fees are computed
 Generally 1 to 2.5% and payable to Investment
Manager, after completion of
 Management Fees are generally the stated fund tenure, in case
paid in arrears, within 14 days of closed-ended funds.
after the relevant valuation day,
when the Gross Net Asset Value
(“GNAV”) of the Category III AIF is
computed. 44
DISTRIBUTION WATERFALL
Priority Sequence Description
1.Expenses, taxes Expenses chargeable to the fund, Income tax on investment gains, GST and other
and statutory statutory dues payable from time to time.
payments
2. Management The management fees of the investment manager, other related costs chargeable
Fees to the fund
3. Capital Net proceeds are to be applied firstly to repay corpus contributions of investors of
Contribution + a particular class on a pro-rata basis and then towards preferred return as per the
Preferred Return terms of the contribution agreement with each class / investor. The manager does
not get any returns until the preferred returns are paid out 100%

4. Additional If the manager / carried interest holders are entitled to additional returns/
Returns / incentives / carry with a catch up clause, the catch up gets paid at this stage so that
Incentives / Carry it equates them to the agreed share on the total return of the scheme / fund.
with Catch Up

5. Residual This is distributed in the ratio of sharing between investors and managers holding
distribution carry.

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PRIVATE EQUITY FUND – DISTRIBUTION
AND FEES
PE Fund Distribution Structure and Manager Fees

• Distribution: Types of Distribution:

• Deal-by-Deal: Preferred by GPs. GPs are given the Carried Interest, in the
distribution waterfall discussed above, after exit from every investee
compay/investment.

• Fund as a Whole – Profits are not given to the LPs and even Carried Interest is not
paid to the GPs, till all exits are made by the Fund and the Fund is liquidated.
More common in Category III AIFs

• Claw-back Provision: If Portfolio returns are High earlier and Decline later, then this
Provision requires the Fund Manager to return any periodic incentive fees paid, if
profits decline in further years from Company Exits and is insufficient to pay the
Hurdle Rate

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PRIVATE EQUITY DISTRIBUTION – DEAL-BY-DEAL
WATERFALL
Particulars Year 2 Year 3 Liquidation of fund

Assume that the Amount invested by the fund is Rs.200 Total proceed to LP Rs. 330 Million
Million in 2 different assets (100 million each). Hurdle Rate is and GP
10% p.a. Catch-up is 30% of Total Profit. Incentive – 20%

Sale Asset 1 proceeds - Asset 2 proceeds - Total Capital Rs. 200 million
Proceeds Rs. 200 million Rs. 130 million Contribution
(net of exp &
reserves)

Capital Rs. 100 mn Rs. 100 mn Fund Profit Rs. 130 million
Hurdle Rs. 21 mn Rs. 30 mn Invested Capital + Rs. 254.10 Million
(10 mn + 11 mn) (10 + 11 + 12.1 mn) Hurdle rate
(33.10 mn not (200 + 21 + 33.10
covered) mn)

Catch-up Rs. 30 mn NA Proceed to GP Rs. 39.80 Million

Carried Bal – 49 mn NA (Invested + hurdle Reqd - Rs. 254.10 mn
Interest Rs. 9.80 mn - GP rate) vs Actual Recd – Rs. 290.20 mn
Rs. 39.20 mn – LP Distributed

Clawback NIL
47
In the same example, calculate the Fees payable to GP
if Asset 2 is sold for Rs. 30 million after Year 3

48
PRIVATE EQUITY DISTRIBUTION – DEAL-BY-DEAL
WATERFALL
Particulars Year 2 Year 3 Liquidation of fund

Assume that the Amount invested by the fund is Rs.200 Total proceed Rs. 230 Million
Million in 2 different assets (100 million each). Hurdle Rate is to LP and GP
10% p.a. Catch-up is 30% of Total Profit. Incentive – 20%

Sale Asset 1 is sold at Rs. Asset 2 is sold for Total Capital Rs. 200 million
Proceeds 200 million Rs. 30 million Contribution

Capital Rs. 100 mn Rs. 30 mn Fund Profit Rs. 30 million

Hurdle Rs. 21 mn NA Invested Rs. 254.10 Million

(10 mn + 11 mn) Capital +
Hurdle rate (200 + 21 + 33.10 mn)

Catch-up Rs. 30 mn NA Proceed to GP Rs. 39.80 Million

Carried Bal – 49 mn NA (Invested + Rs. 254.10 Million –

Interest Rs. 9.80 mn - GP Rs. hurdle rate) - Rs. 190.20 Million =
39.20 mn – LP Actual Rs. 63.90 million
Distributed

Clawback Rs. 39.80 Million

(Bal. 24.10 is loss for LP)
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PORTFOLIO MANAGEMNET –
INSTITUTIONAL PORTFOLIOS

• How will you manage portfolios of an Institution?

• What are the Investment Objectives and Constraints?

50
PORTFOLIO MANAGEMNET –
INSTITUTIONAL PORTFOLIOS
INVESTMENT POLICY STATEMENT AND INVESTMENT OBJECTIVE

Endowments (Example: Scholarship purposes)

• Asset Allocation – 90% G-Secs, 10% Money Market Instruments

• Risk – Very low risk

• Return – (5% to 8%)

• Time Horizon – Long term (10+ years)

• Liquidity – Periodic liquidity needs to meet university cash-flows arising at pre-defined

intervals

• Unique Tastes & Preferences –

• Investment in areas which are non-profit
• Investment related to building up assets for the institution or R&D

51
PORTFOLIO MANAGEMNET –
INSTITUTIONAL PORTFOLIOS
INVESTMENT POLICY STATEMENT AND INVESTMENT OBJECTIVE

Banks
Objective: Compliance with RBI SLR
Risk: Low
Return: Low, capital protection
Tax: Corporate tax rate
Asset Allocation
• Fixed income – 90%
• Equity - 10%
Regulatory Requirements (Instruments allowed)
• ‘A’ or equivalent and higher rated commercial paper/debentures/bonds
• Units of debt mutual funds and money market mutual funds
• Shares of Market Infrastructure Institutions (MIIs)

52
PORTFOLIO MANAGEMNET –
INSTITUTIONAL PORTFOLIOS
INVESTMENT POLICY STATEMENT AND INVESTMENT OBJECTIVE

Mutual Funds – Equity Funds

Open Ended Asset Allocation (Indicative)
Objective: Long term capital appreciation • Large cap equity: 35% - 65%
Strategy: Blend of growth & value investing • Mid cap equity: 35%-65%
• Other equity: 0%-30%
Time: Long term
• REITs/InvITs: 0%-10%
Risk: High, capital loss
• Debt instrument: 0%-30%
Constraints
• Money markets: 0% - 30%
• Liquidity: High, cannot invest in illiquid instruments
• Regulatory: SEBI regulations
• The scheme shall not invest more than 10% of its net
assets in the equity shares of a company
• Investment limited to 5% in unlisted equity shares

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PORTFOLIO MANAGEMNET –
INSTITUTIONAL PORTFOLIOS
INVESTMENT POLICY STATEMENT AND INVESTMENT OBJECTIVE

Family Offices
• Asset Allocation – Primarily Equity only (usually through Hedge Funds, Venture Capital or Seed Funding)

• Risk – Very High Risk

• Return – Very high expected returns as a result of venture or seed funding

• Time Horizon – Long term (5+ years)

• Liquidity – Mostly illiquid as investments into private companies; exchange-trade equity is liquid

• Unique Tastes & Preferences –

• High-ticket concentrated investments

• Preference for ensuring a controlling stake in invested firms
• Willingness to undertake highly risky investments
• Preference to invest in the high-growth phase of companies and exiting in the IPO route

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DIVERSIFICATION – NEED OF THE HOUR!

Professional Managers should not hesitate to allocate

funds to other professional managers –

Diversification to other Asset Classes and Investment

Strategies is key to reduce Portfolio Risk

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ALTERNATIVE INVESTMENT FUNDS –
DEFINITION
Any fund:
 Established or Incorporated in India
 In the form of a trust, company, body corporate or limited liability partnership

Which is a :
 Privately pooled investment vehicle which collects funds from investors, whether Indian
or foreign, for investing it in accordance with a defined investment policy for the benefit
of its investors, AND
 Not covered under SEBI (Mutual Funds) Regulations, SEBI (Collective Investment
Schemes) Regulations or any other regulation governing fund management activities.

Following types of Funds are NOT considering as Alternative Investment Funds:

• Family Trusts set up for the benefit of ‘relatives’ under Companies Act, 1956
• ESOP Trusts
• Employee welfare trusts or gratuity trusts set up for the benefit of employees.
• Holding Companies
• Special purpose vehicles not established by fund managers, such as securitization trusts
• Asset Reconstruction Companies (ARCs)
• Funds managed by Securitization company or Reconstruction company
• Any such pool of funds which is directly regulated by other Regulator in India
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ALTERNATIVE INVESTMENT FUNDS –
TYPES
• Employ diverse or complex investment strategies.
Hedge Funds • Invest or trade in securities having diverse risks or complex products
including listed and unlisted derivatives.

• Invest in equity or equity linked instruments of investee companies

Private Equity Funds
according to the stated objective of the fund.

• Invest in unlisted securities of start-ups, emerging or early-stage

Venture Capital undertakings.
Funds (incl. Angel • Such companies are mainly involved in new products, new services,
Funds)
technology or IPR activities.

• Invest in unlisted securities of companies which are SMEs or

SME Funds • securities of those SMEs which are listed or proposed to be listed on a SME
exchange.

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ALTERNATIVE INVESTMENT FUNDS –
TYPES
• Invest in unlisted securities, listed or securitized debt instruments of investee
companies
Infrastructure Funds • Can form Special purpose vehicles for the purpose of operating, developing or holding
infrastructure projects

• Invest primarily in debt or debt securities of listed or unlisted investee companies

Debt Funds according to the stated objectives of the Fund.

• Invest in securities or units of social ventures as per social performance norms laid
down by the fund.
Social Venture Funds • Investors may agree to receive restricted or muted returns.
• Social Venture: Purpose of promoting social welfare or solving social problems or
providing social benefits.

Special Situations • Invests in special situation assets in accordance with its investment objectives
Funds • May act as a resolution applicant under the Insolvency and Bankruptcy Code, 2016.

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ALTERNATIVE INVESTMENT FUNDS –
CATEGORIES

Category I Category II Category III

• Invest in socially or • Funds not falling in • Funds employ diverse
economically Category I and or complex trading
desirable ventures. Category III strategies

• Examples: • Not allowed to take • Allowed to take

1. Venture Capital leverage, except to Leverage and
Funds, meet day-to-day Investments in
2. SME Funds, operations. Derivatives.
3. Social Impact Funds
4. • Examples: • Example: Hedge Funds
Infrastructure Funds 1. Debt Funds
5. Special 2. Private Equity Funds
Situations Funds

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AIF REGULATIONS – KEY PROVISIONS

‘Accredited Investors’ means any person who is granted a certificate of accreditation by an

accreditation agency, based on the following eligibility criteria:

Individual, Hindu Undivided Family (“HUF), Family Trust, Sole Proprietorship or Partnership:
• Annual income should be at least Rs. 2 crore; or
• Net worth should be at least Rs. 7.50 core, out of which at least Rs. 3.75 crore should be in
the form of financial assets; or
• Annual income should be at least Rs. 1 crore and minimum net worth to be Rs. 5 crore,
out of which at least Rs. 2.50 crore should be in the form of financial assets

Body Corporates and Trusts:

• Net worth should be at least Rs. 50 crore

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AIF REGULATIONS – KEY PROVISIONS

The following institutions shall deemed to be an accredited investor :

• Central Government and the State Governments
• Funds and Developmental Agencies set up by the Central Government or the State
Governments
• Qualified institutional buyers as defined under SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2018
• Category I foreign portfolio investors
• Sovereign wealth funds and multilateral agencies

“Large value fund for accredited investors” means an AIF or scheme of an AIF in which each
investor (other than the Manager, Sponsor, employees or directors of the Fund or employees
or directors of the Manager) is an accredited investor and invests at least Rs. 70 crore

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PRIVATE PLACEMENT MEMORANDUM

What are the components of a PPM?

https://www.sebi.gov.in/sebi_data/comm
ondocs/dec-2019/Annex_A_p.PDF

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AIF REGULATIONS – KEY PROVISIONS

* Separate terms and conditions apply for Category I – VCF (Angel Funds)
** In case of investors who are employees or directors, the minimum value of investment shall
be Rs.25 lacs

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AIF REGULATIONS – KEY PROVISIONS
Sr. Particulars Category I Category II Category III
No.
6. Tenure Close ended – Minimum 3 years Optional - Open or
Note: Extension of tenure is permitted up to 2 years, Close ended
subject to approval of 2/3rds of unit holders by value
7. Investment in 25% of the Investible Funds 10% of the Investible
Single Company Funds
8. Investment in Requires approval of 75% of the unitholders (by holding)
Associates
9. Leverage Only for meeting temporary funding requirements for Can take leverage,
not more than 30 days, on not more than 4 occasions subject to consent
in a year and not more than 10% of investible funds from the investors
Note: Category II funds may engage in hedging subject maximum limits
to guidelines specified by the SEBI specified by SEBI.
10. Valuation Once every 6 months by an independent valuer Calculation of NAV,
independent of fund
management.
Disclosed quarterly for
closed ended funds
and monthly for open
ended funds.

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FUNDS-OF-FUNDS
Funds of Funds
 A Funds of Funds (F-o-F) invests its Assets in various hedge funds.

 It provides diversification among hedge fund strategies, as it invests in different types of

Hedge Funds, thus allowing small investors to access/invest in hedge funds for which
they might not qualify to invest.

 Fees charged by the F-o-F is higher than fees charged by a Hedge Fund. This is because
the Manager of the F-o-F charges a certain Fees, over and above the Fee normally
charged by the Hedge Fund Managers in which the F-o-F invests.
 The most common F-o-F Fee Structure is “1 and 10”, which is over and above
“2 and 20” HF Fees.

 F-o-F tend to redeem their money faster than other investors when Hedge Funds start to
perform poorly. Hence the F-o-F money is often referred to as “fast” money.

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AIF REGULATIONS –
PROACTIVE MEASURES BY SEBI
Updates on Regulations
• Filing PPM through a Registered Merchant Banker, who files a Due Diligence Certificate

• Calculation of investment restrictions based on NAV or “Investible Funds”

• No Differential rights while distribution of Loss

• Change in Sponsor, based on a case in NCLT – To file application with SEBI for in-principal
approval valid for 3 months. AIF to file application with SEBI within 15 days of NCLT order

• AIFs can invest in Overseas Company, if the country is a member of the IOSCO

• Excused Investors from an Investment, based on disclosures in Contribution Agreement

• Direct Plan for AIF Schemes and Trail-based Commission Model (Equal-basis for Cat III)

• Participation of AIFs in CDS, as a Protection Seller and Protection Buyer

• Publishing Investor Charter by AIFs and Disclosing complaints against the AIF
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