Specialised Investment Funds (SIFs): A Guide for Indian HNIs

Specialised Investment Funds (SIFs) represent a significant evolution in the Indian financial landscape, offering a novel investment avenue tailored to the needs of High Net-worth Individuals (HNIs). These funds are designed to provide access to sophisticated investment opportunities that go beyond the scope of traditional mutual funds, potentially offering enhanced returns alongside increased risk. 

For HNIs seeking to diversify their portfolios and explore niche markets with potentially lower minimum investment thresholds compared to Alternative Investment Funds (AIFs), SIFs present a compelling option.

Specialised Investment Funds (SIFs) are investment vehicles in India that are regulated by the Securities and Exchange Board of India (SEBI). These funds pool capital from accredited investors and HNIs with the primary objective of investing in specific, often non-traditional, asset classes or employing sophisticated investment strategies. 

A key differentiator for SIFs compared to traditional mutual funds is the enhanced flexibility afforded to fund managers, including the ability to engage in strategies such as short selling, where they can bet against the price of a stock, up to a limit of 25% of their net portfolio using derivatives. This feature provides a tool for potentially generating returns in both upward and downward trending markets, leading to more dynamic investment strategies. 

Despite this increased freedom in investment strategy, SIFs operate within a regulated environment overseen by SEBI. They are designed to bridge the gap between conventional mutual funds, which typically have broader investment mandates and often lower minimum investment amounts, and AlFs), which come with higher investment thresholds.

SIFs will invest in equities, debt, commodities, REITs & INVITs and derivatives related to these instruments. However, these schemes can go short in equity and debt derivatives only. 

SIFs offer sophisticated and customized investment strategies, including the flexibility to structure themselves as open-ended, close-ended, or interval funds, and to employ diverse approaches like long-short equity, debt, and hybrid strategies, thereby catering to a wide spectrum of risk appetites and investment objectives. 

Due to the ability to utilize more active and potentially higher-risk strategies, SIFs hold the potential for better returns compared to more conventional investment options. 

The regulatory framework governing SIFs also allows for greater flexibility in pursuing niche investments. HNIs benefit from the expertise of experienced fund managers who are equipped to navigate the complexities of these specialized strategies and markets.

To better understand the positioning and characteristics of Specialised Investment Funds, it is helpful to compare them with traditional investment options commonly available in India. The following table highlights key differences across several important parameters:

This comparison illustrates that SIFs occupy a unique space in the investment landscape. They offer more strategic flexibility than traditional mutual funds, including the ability to employ strategies like short selling, while having a lower minimum investment threshold than most PMS offerings.

Although regulated by SEBI like both mutual funds and AIFs, the specific regulations for SIFs are tailored to their specialized nature. The risk and potential return profiles of SIFs are generally higher than those of traditional mutual funds but might be comparable to some AIF strategies, depending on their focus.

The regulatory framework for Specialised Investment Funds permits three distinct core investment strategy categories: Equity-Oriented, Debt-Oriented, and Hybrid Strategies.

Equity-Oriented Strategies primarily focus on investing in equity and related instruments. Examples of fund types within this category include Equity Long-Short Funds, which take both long (buy) and short (sell) positions in equity stocks, Equity ExTop 100 Long-Short Funds, which

might focus on stocks outside the top 100 by market capitalization while employing long-short strategies, and Sector Rotation Long-Short Funds, which dynamically adjust their long and short positions across different sectors based on market outlook. Notably, equity-oriented SIFs are mandated to invest at least 80% of their net assets in equity and related instruments. 

Debt-Oriented Strategies 

Debt-Oriented Strategies, on the other hand, concentrate their investments predominantly in debt instruments. Examples in this category include Debt Long-Short Funds, which might take long and short positions in various debt securities, and Sectoral Debt Long-Short Funds, which focus on specific sectors within the debt market. 

Hybrid Strategies 

Hybrid Strategies involve a combination of both equity and debt instruments within the portfolio. Examples here include Active Asset Allocator Long-Short Funds, which dynamically manage the allocation between equity and debt while potentially using long-short strategies in either or both asset classes, and Hybrid Long-Short Funds, which maintain a more static mix of equity and debt while employing long-short techniques. 

It is important to note that the current regulations permit only one investment strategy under each of these three categories per SIF, which is likely intended to ensure a focused investment approach within each specialized fund. 

This categorization of SIF strategies provides a clear framework for HNIs to understand the investment focus and potential risk-return characteristics of different SIF offerings. This classification aligns with the familiar categorization used for traditional mutual funds, which can aid investors in navigating the SIF landscape.

A significant aspect of Specialised Investment Funds, and one that holds particular appeal for sophisticated investors, is the ability to employ long-short investment strategies. At its core, a long-short strategy involves simultaneously investing in companies that are considered fundamentally strong and likely to appreciate in value (taking a ‘long’ position) while also betting against companies that are perceived as overvalued or fundamentally weak or facing headwinds and expected to decline in price (taking a ‘short’ position). 

One of the potential benefits of this strategy is its ability to provide a degree of downside protection during market downturns, as the short positions can potentially offset losses from the long positions. Additionally, it offers the possibility of generating returns in both rising and falling markets, as profits can be made from both the appreciation of long positions and the depreciation of short positions. 

However, it is crucial to acknowledge the challenges and considerations associated with effectively executing a long-short strategy. It requires a high degree of skill and expertise in

identifying both promising long candidates and suitable short candidates. Furthermore, this strategy can be particularly difficult to implement successfully in strongly trending markets, whether they are consistently bullish or bearish. 

Data from global hedge funds, which pioneered long-short strategies, indicates that they have not always outperformed broader market indices, highlighting the complexities involved. The success of a long-short strategy is heavily reliant on the fund manager’s ability to make accurate assessments and time the market effectively. 

HNIs must recognize that this approach is not a guaranteed path to higher returns and necessitates careful selection of fund managers with a proven track record in this specialized area. The inclusion of long-short strategies within the SIF framework provides HNIs with access to an investment tool that has historically been associated with more exclusive investment vehicles like hedge funds, now available within the regulated structure of Indian mutual funds.

According to the regulations, each SIF investment strategy will follow a single-tier benchmark, which serves as the primary reference point for evaluating its performance. 

Additionally, there is an option to include a second-tier benchmark, which could potentially offer a more granular comparison against a specific market segment or a peer group of similar strategies. 

For equity-oriented strategies, benchmarks would typically be broad equity market indices or sector-specific indices, depending on the fund’s focus. For debt-oriented strategies, relevant debt market indices based on credit quality and duration would be appropriate. Hybrid strategies would likely use a composite benchmark that reflects the allocation between equity and debt in the fund’s portfolio. 

When evaluating the performance of SIFs, HNIs should consider various metrics beyond just absolute returns. Risk-adjusted returns, which take into account the level of risk taken to achieve those returns, are particularly important for SIFs given their potentially higher risk profile. 

Consistency of performance over different market cycles is another key factor to assess. Comparing the fund’s performance against its designated benchmark(s) will help investors determine if the fund manager is adding value beyond what could be achieved by simply investing in a passive index. 

SIFs are susceptible to overall market fluctuations, and the specific asset classes they invest in carry their own inherent risks, such as equity market volatility and credit and duration risk in debt markets. 

The investment strategies employed by SIFs also introduce specific risks. For instance, short selling carries the potential for unlimited losses if the price of the shorted stock rises instead of falling. The reliance on the fund manager’s expertise and decision-making is particularly critical for these complex strategies, introducing fund manager risk. 

Liquidity risk can also be a concern, especially for SIFs investing in less liquid assets or those with close-ended structures, and investors should be aware of potential notice periods for redemption. 

While these risks are significant, the regulatory framework does incorporate certain safeguards to protect investors, such as limits on investment exposures and mandatory disclosure requirements. Additionally, AMCs are required to disclose the risk level associated with each SIF strategy through a “Risk-band,” a pictorial risk meter similar to that used for mutual funds.

Before investing in Specialised Investment Funds, HNIs should carefully consider several crucial factors. The investment horizon should align with the potentially longer timeframes associated with the alternative asset classes that SIFs may invest in. 

Assess Risk Appetite:

Investors must honestly assess their own risk appetite and ensure they are comfortable with the higher levels of investment risk inherent in SIFs. The mandatory minimum investment of ₹10 lakh should be within their investment capacity. 

Familiarity with Investments:

A thorough understanding of the specific sectors and investment strategies targeted by the SIF, along with an evaluation of their growth prospects and associated risks, is essential. It is also important to research the experience and track record of the fund manager and the AMC managing the SIF. 

Understanding of the Fund Structure:

Investors should understand the fund’s structure (open-ended, close-ended, or interval) and the potential limitations on liquidity, including any applicable notice periods for redemption; for close-ended and interval funds, the listing on stock exchanges as a potential exit route should be noted. 

Fees:

The fees and expenses associated with the SIF should be carefully reviewed, as they can impact overall returns. It is crucial to verify that the SIF is indeed regulated by SEBI and complies with all relevant guidelines. 

Tax Implications: 

Understanding the tax implications of investing in SIFs, which are similar to those of equity mutual funds regarding capital gains tax, is important. The due diligence process for SIFs is more critical than for traditional mutual funds due to their increased complexity and risk. 

HNIs need to examine the specifics of the fund’s strategy and the fund manager’s expertise. 

Prospective investors should also meticulously review the offer documents and the Investment Strategy Information Document (ISID) to fully comprehend the fund’s objectives, strategies, risks, and terms and conditions. 

Specialised Investment Funds are designed for a specific segment of investors who possess certain characteristics and investment profiles. These funds are generally suitable for experienced investors who have a strong understanding of financial markets and various investment strategies, including potentially complex ones like long-short strategies and derivatives. 

Given the minimum investment threshold, SIFs are primarily targeted towards High Net-worth Individuals (HNIs) who meet the financial criteria and have the capacity to absorb potential investment losses. Sophisticated investors seeking advanced and flexible investment options that go beyond the scope of traditional mutual funds and who are potentially looking for higher returns may find SIFs appealing. 

Investors with a higher tolerance for risk and who are comfortable with the potential for significant volatility and losses in pursuit of potentially greater returns are also well-suited for SIFs. 

Those with a long-term investment horizon that aligns with the potentially extended time frames required for some of the alternative asset classes and strategies employed by SIFs should consider them. 

Finally, investors looking to further diversify their portfolios into niche markets and alternative asset classes that are not readily accessible through conventional investment routes might find SIFs to be a valuable addition. 

SIFs are not a one-size-fits-all investment solution and are specifically tailored for a segment of the market with a particular risk appetite, financial capacity, and investment knowledge. HNIs

who are new to investing or prefer a more conservative approach might find SIFs less suitable for their portfolio.

As a dedicated wealth management service for High Net-worth Individuals in the Indian market, EquiZen is well-positioned to assist you in navigating the landscape of Specialised Investment Funds. 

Our experienced financial advisors possess a deep understanding of the intricacies of SIFs and can provide expert guidance tailored to your specific financial goals and risk tolerance. We can help you understand the nuances of different SIF strategies, evaluate their suitability for your portfolio, and conduct thorough due diligence on various fund offerings.

Specialised Investment Funds in India present a unique set of opportunities for High Net-worth Individuals seeking to enhance their portfolio diversification and potentially achieve higher returns through access to niche markets and sophisticated investment strategies. 

However, it is crucial to recognize that these opportunities come with a higher degree of risk compared to traditional investment options. Therefore, before considering an investment in SIFs, HNIs must conduct thorough research and due diligence to fully understand the specific investment strategies, the expertise of the fund manager, the associated risks, and the regulatory framework governing these funds. 

Given the complexity and the potential for significant financial implications, it is highly advisable for HNIs to consult with their financial advisors to determine if SIFs align with their individual investment goals, risk tolerance, and overall financial plan. A well-informed decision, based on a comprehensive understanding of the intricacies of SIFs, is paramount for HNIs looking to explore this evolving investment landscape.