India’s Wealthy Pull Out Money From Short-Term Alternative Investment Funds

India’s super-rich withdrew commitments made to hedge funds and other such short-term investment vehicles for the first time in nearly seven years after the increase in tax rates for the wealthy.

Commitments by high-net-worth investors to Category-III alternative investment funds fell Rs 4,832 crore quarter-on-quarter to Rs 42,223.4 crore in the three months ended September, according to data released by the Securities and Exchange Board of India. That’s the first quarterly decline since SEBI started registering such funds in December 2012.

The wealthy also redeemed money during the quarter. Investments raised by such funds fell Rs 2,933 crore to Rs 36,912.3 during the quarter, while money invested declined Rs 2,247 crore to Rs 30,961 crore.

That came after Finance Minister Nirmala Sitharaman in her July 5 budget increased taxes on the super-rich, including trusts and association of persons. While foreign portfolio investors got relief later, other investors didn’t. Category III alternate investment funds, including long-short, hedge and PIPE funds, are structured as trusts and are now taxed at 42.74 percent on the business income.

Long-short funds have been impacted by the increase in taxation in the budget and this led to some redemptions in the funds which were focused on giving conservative debt plus returns to clients, Gaurav Awasthi, senior partner at IIFL Wealth, said. Some bit of outflow, he said, would also be due to maturity of existing funds as well as redemptions in ongoing funds.

Together with the commission and management charges, the returns became unviable leading to the withdrawal of commitments and redemption in many funds, a senior executive at a domestic wealth management company said on condition of anonymity as he isn’t authorised to speak to the media.

There are 125 category-III registered AIFs requiring a minimum investment of Rs 1 crore from investors. A large number of these are long-short funds managing a combined Rs 8,000-10,000 crore, mostly invested in derivatives, according to the person quoted earlier.

The income they generate through trading is considered as business income which attracts the super-rich tax rate. Along with other levies, including capital gains tax and commissions, nearly 50 percent of the returns are deducted, said a second person who is involved in the distribution of AIFs. That leaves very little with the investor, the person said on the condition of anonymity as he is not authorised to speak to the media.

Category-III funds also bought small- and mid-cap stocks to beat benchmark returns, said the first person quoted earlier. In the last 18 months, there hasn’t been much to show, he said, adding that quite a few of the funds have shown negative returns as stocks tumbled 30-40 percent in the last one year.