Avendus Capital has recently launched a Category III Alternative Investment Fund (AIF) – Avendus Market Neutral Fund. Market neutral funds are funds that are both long and short on stocks, thereby reducing or eliminating market risk.
Many AIFs that partially hedge their portfolios already exist but very few funds in India want to do away with it completely. Such a strategy can beat a simple ‘buy and hold’ or ‘long only’ strategy in a down trending market. Nifty is down 11% since the beginning of 2022. However, experts suggest buying into such funds only after establishing a track record. Since such funds are AIFs, they have a minimum ticket size of ₹1 crore.
Avendus Market Neutral Fund, which seeks to eliminate market risk completely, will be allowed to deviate from 100% hedge positions (long and short positions of equal magnitude) by only 10%. It will do this using stock futures and will primarily target the 100 largest listed companies. Avendus Capital already has one such offering – Avendus Absolute Return Fund. However, the new scheme will use a quant-based strategy and target post-tax and post-expert returns of 8-11%.
“There are two types of risks involved in equity investment. The first is market risk, which is the risk of the entire market going up or down. The second is stock selection risk, which is the risk of choosing the wrong stock. Our model will eliminate the former (market risk). We will use a combination of momentum, average reversion and factor-based investing to determine which stocks will last long and which will be short,” said Vaibhav Sanghvi, Co-CEO, Avendus Capital Public Markets Alternative Strategies. According to Sanghvi, such diversified strategies will reduce the risk of mis-trading. It will be open ended with an exit load of up to a holding period of 6 months. For investments from ₹1 crore to ₹5 crore, the fund will have a management fee of 1% and a performance fee of 25% above the constraint of 10%. For example, if your ₹1 crore corpus gives a return of ₹20 lakh, Avendus will charge a management fee of ₹1 lakh. There will also be a performance fee charged on returns above 10%. This return comes out to ₹9 lakh (after factoring in the management fee) and hence the performance fee will be ₹2.25 lakh.
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In India, Category III AIFs—some of which hedge their risks—have so far shied away from being completely market neutral. A major reason for this is the tax treatment of such funds. “Category III AIFs have to deduct 42.7% tax at source on business income which is treated as income from business and profession. This largely eats into the after-tax returns. This is the reason why market neutral funds have not come up in a big way in India so far,” said Nalin Moniz, chief investment officer, alternative equities, Edelweiss Asset Management Ltd.
Avendus Market Neutral Fund is targeting a post tax return of 8-11%. This translates into a pre-tax return of 19-26% if you are in the highest tax bracket. For those falling in the 30% tax bracket, the post-tax return will be higher.
A market neutral fund can outperform a traditional long-only equity fund in a bear market or a relatively range-bound market. However, investors should pay attention to taxes. Stock selection risk or the risk of the fund manager choosing the wrong stock to go long and short also remains on the table. “For all algo and volume based strategies, we typically look at a minimum of 1 year and ideally 2 years of actual portfolio data. Backtested returns have their own dilligence challenges,” said Munish Randev, Founder and CEO, Servin Family Office .
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