Alternative Asset Management for HNI

High net-worth individuals (HNIs) in India have traditionally invested in physical assets like gold and real estate, direct stocks, fixed deposits, and bonds to grow their wealth. However, HNIs must look beyond traditional options for better returns and portfolio diversification in the evolving investment landscape.

This article discusses the merits of adding alternate investment avenues to an HNI portfolio.

The Need for Alternate Investments

HNIs face several issues with conventional investment options:

1. Lack of diversification: Investing majorly in physical assets like property or gold leads to concentration risk. Market downturns impact portfolio value.

2. Lower than expected returns: Fixed income options like FDs generate lower post-tax returns today due to falling interest rates.

3. Liquidity challenges: Physical assets like real estate may not find buyers easily during emergencies.

4. Volatility risks: Equity markets have become unpredictable, increasing downside risks.

5. Rising inflation-eating returns: Double-digit inflation hurts portfolio value if appropriate inflation hedges are missing.

Alternative investments can help HNIs diversify and earn higher returns over the long term. By investing 10-25% of their portfolio value, they can mitigate risks and optimise unique opportunities.

Popular Alternate Investment Avenues

Here are some popular alternate investment avenues for HNIs:

1. Alternative Investment Funds
2. Structured Products
3. REITS and InvITS
4. Pre-IPO Placements
5. International Investments

Alternative Investment Funds

Alternative Investment Funds or AIFs allow the pooling of capital from institutional and HNI investors to invest in non-traditional asset classes like private equity, real estate, and infrastructure, among others, following a defined investment strategy.

Benefits of Investing in AIFs

1. Portfolio diversification: The returns from AIFs have a low correlation with traditional bonds and stocks

2. Healthy returns: Funds aim to generate higher risk-adjusted returns through exposure to alternative assets

3. Inflation hedge: Investments in real assets act as an inflation hedge during rising prices

4. Reduce concentration risk: AIFs invest across asset classes and sectors, spreading out risk

Types of AIFs Where HNIs Can Invest

SEBI has approved three categories of AIFs suitable for HNIs:

1. Category I AIFs: These invest in startups, SMEs, infrastructure, or social welfare projects with higher risk but superior return potential over the long term

2. Category II AIFs: This flexible category allows investments in unlisted securities with some leverage exposures across asset classes through varied strategies

3. Category III AIFs: This category aims to generate returns linked with the market by utilising complex trading strategies such as long/short equity, derivatives, etc.

Expected Returns

On average, AIFs aspire to provide 15-25% annual returns, helping HNIs grow their wealth faster. However, past performance may not be sustained, and thorough due diligence of specific funds is critical before investing.

Minimum Investment Amount

The minimum ticket size to invest in AIFs is ₹1 crore with a lock-in of 1-6 years, depending on the fund strategy and category. This threshold restricts smaller investors from accessing AIFs.

Risk Factors in AIFs

A few notable risks involved while investing in AIFs are:

• Higher risk due to exposure to unlisted, illiquid securities
• Higher complexity involving leverage, derivatives, etc.
• Loss potential if fund manager’s calls go wrong
• Lack of investment flexibility due to lock-ins

Steps to Invest in AIFs

Here are the steps HNIs should follow to invest in AIFs:

1. Determine investment goals and expected returns

2. Chalk out asset allocation for alternate investments

3. Research suitable AIF categories and strategies

4. Evaluate past performance, fund manager reputation, etc., through advisors

5. Select AIF aligning with goals and risk appetite

6. Route investment through advisors and wealth managers

Structured Products

Structured products offer structured payouts to investors linked to the performance of an underlying security like equity, debt, etc. Some popular examples are:

• Principal Protected Notes: Offers upside exposure to the underlying index while protecting downside risk
• Reverse Convertibles: Gives fixed returns while converting into equities on maturity based on share price movements

Benefits of Structured Products

Some benefits of investing in structured products are:

1. Equity participation without full risks involved
2. Higher risk-adjusted returns compared to traditional options
3. Structured returns aligned to investor needs
4. Part principal protection offered in certain variants
5. Fills the gap between fixed income and equities

Popular Structured Products for HNIs

Here are some structured products suitable for HNIs:

• Market-linked debentures
• Index-linked NCDs
• Principal-protected equity funds
• Equity structured notes

Expected Returns

Structured products can generate an average 10-15% annual returns, leveraging the underlying indices. Certain principal protected variants also guarantee capital apart from index-linked gains.

Minimum Investment

Most investors can start investing in structured products with as low as ₹25,000-50,000. However, HNIs invest significantly higher amounts for better product features and returns.

Risk Factors

While structured products seem attractive, they also pose the following risks:

• Credit risk arising out of issuer default
• Liquidity risk due to lack of secondary market
• Complex payout structures are difficult to comprehend
• Mis-selling due to aggressive selling and lack of transparency

Steps to Invest

HNIs can invest through these steps:

1. Determine the need for structured investments
2. Research product features, underlying asset class
3. Check issuer rating and product liquidity
4. Review payout structure and returns clarity
5. Invest through trusted wealth advisors

Real Estate Investment Trusts & Infrastructure Investment Trusts

REITs and InvITs allow small investors to participate in income-generating real estate and infrastructure projects. Their key features are:

• Listed products providing liquidity through the secondary market
• Mandated to provide over 90% of net income as dividend payouts periodically
• Professionally managed by experienced asset managers

Benefits of Investing in REITs and InvITs

The major benefits are:

1. Enables smaller investments: REITs and InvITs allow investments starting ₹15,000-25,000, making participation easier
2. Steady income: Higher dividend payouts averaging 7-9% per annum act as a regular income source
3. Diversification into real assets: Adds diversification into real estate and infrastructure sectors
4. Lower risks: Professionally managed portfolio spreads out risks across projects
5. Liquidity through the secondary market: The listed structure allows entry and exit based on price movements

Expected Returns

REITs and InvITs can generate pre-tax returns between 10-12% annually through rising NAVs and dividend payouts.

Risk Factors

• Declining rentals impacting dividends
• Higher interest rates leading to investment value erosion
• Execution delays in underlying projects
• Liquidity risks arising due to thin trading volumes

Steps to Invest

HNIs can invest through the following steps:

1. Assess the need for real estate and infra exposure

2. Research available REIT & InvIT options

3. Analyse the portfolio across locations, sectors, tenants, etc.

4. Review past performance, corporate governance standards

5. Invest directly or through advisors

Pre-IPO Placements

HNIs get opportunities to invest in fast-growing private companies looking to go public through pre-IPO placements.

Benefits of Pre-IPO Investments

1. Get ahead of the crowd by investing before the hype around a company going public drives up prices.
2. Save money by investing in a company before it goes public, allowing you to make more profit when it does potentially.
3. Invest in new and innovative companies that have the potential for high returns.
4. Choose whether to sell your investment or continue to hold onto it and benefit from the company’s growth after it goes public.

Returns Potential

Pre-IPO deals can generate over 20-25% returns within short timeframes of 6-12 months, leading to exponential wealth creation.

Risks

• Business model risk before financial performances are proven
• Delay in listings providing no exit route
• Overpricing without fundamentals backing valuations
• Illiquidity forcing longer holding periods

Minimum Investment

HNIs need to invest at least ₹25-50 lakhs to participate in pre-IPO rounds due to higher ticket sizes.

Steps to Invest

Route pre-IPO investments through:

1. Leading merchant banks facilitating unlisted deals

2. Category 1 AIFs participating as pre-IPO investors

3. Early-stage focused VC funds

International Investments

HNIs also look at international markets like the US, UK or Singapore to diversify portfolios geographically.

Benefits of International Investments

1. By diversifying your investment portfolio beyond your home country, you can reduce the risk of losing money if something bad happens in your local economy.
2. By investing in global markets, you can benefit from growth opportunities beyond your home country, which may be affected by different factors than those affecting your local market.
3. By investing globally, you can protect your money against potential losses due to the depreciation of your local currency or changes in your local market.
4. By investing in a variety of assets globally, such as stocks, real estate, and global indices, you can increase your exposure to different markets and improve your returns.

Investment Avenues Abroad

HNIs can explore these options:

• Overseas mutual funds/ETFs
• Direct equity picks through the LRS route
• International structured products
• Overseas physical assets

Expected Returns

Target returns vary based on underlying asset class – developed market equity can yield 10-15% and global real estate 4-7%. Currency movements also impact returns.

Minimum Investment

Most global investment options require an initial investment of USD 10,000 or equivalent under the LRS route.

Risk Management

Key risks and their mitigation:

• Currency Risk – Diversify across currencies
• Political Risks – Avoid concentration in a few geographies
• Lack of transparency – Invest only through regulated entities
• Costs – Choose low-cost funds / ETFs

Steps to Invest

Route international investments through:

1. Approved banks under the LRS route

2. India-based feeder funds investing abroad

3. India’s arms of global wealth managers

Conclusion

HNIs have many different investment options to choose from these days. By investing in different types of investments, HNIs can make more money and protect themselves from losing too much if the market goes down. It is important to get expert advice if you’re considering investing in something complicated. By being smart and investing in various things, HNIs can reach their financial goals faster.

Many options are available, so it is important to choose carefully and gradually invest around 15-25% of your total money to ensure your investments are diverse enough. Sticking with your investments for a long time and avoiding sudden changes is also important.

Frequently Asked Questions

Why should HNIs consider adding alternate investments to their portfolio?

The alternate investment avenues can provide portfolio diversification, healthy returns, inflation hedges, and reduced concentration risk to HNI portfolios over traditional options like equity, debt, and real estate.

What are the major risks of investing in Category III Alternative Investment Funds (AIFs) for HNIs?

Some notable risks of Category III AIFs are higher complexity due to using leverage and derivatives, the potential for losses if the fund manager’s calls fail, and lack of flexibility owing to lock-in rules.

How can investing in Real Estate Investment Trusts (REITs) benefit HNI investors?

REITs allow even smaller investments from INR 15,000, providing steady rental income, real estate sector diversification, lower risks due to professional management and liquidity due to their listed structure.

What minimum ticket size is recommended for HNIs to invest in overseas investment options?

Most global investment avenues mandate a minimum investment of around USD 10,000 or equivalent for participation by HNIs under the Liberalized Remittance Scheme route

What target returns range is possible from a well-diversified alternate investment portfolio?

Alternate avenues across asset classes that can generate annual returns between 15-25% for HNIs, thereby enabling superior portfolio performance.