In today’s Finshots, we try to make sense of SEBI’s newly proposed asset class.

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The Story

Durga is a retired banker. Life’s been good to her, and she’s happily settled into this phase. But she’s not one to sit idle, especially when it comes to her savings. With ₹10 lakhs in hand, she’s searching for an investment that could help cover her grandchildren’s college expenses in a few years. As a banker, she’s already put enough into fixed deposits (FDs) and is now hoping for something with higher returns.

Mutual funds seem like a promising option. But just as she’s mulling it over, her friend throws a curveball. “What if the market tanks because of some unexpected event? You could lose more than just the returns. You might not even get your money back”, her friend warns.

This friend then suggests an alternative, a scheme run by a chap named Lena Bhai. Apparently, Lena Bhai promises a foolproof investment plan with a guaranteed 20% return every year. And the best part is that Durga’s money not only stays safe, but her grandkids’ education fund is secured too. It sounds perfect, and Durga, fully convinced, is ready to meet Lena Bhai and invest.

But here’s the catch. If you’ve been following the markets, you’d know that Lena Bhai’s scheme is way too good to be true. No legitimate investment can guarantee such high returns without some serious backing.

In fact, SEBI (Securities and Exchange Board of India), the market regulator, doesn’t allow mutual funds or any investment schemes to promise assured returns unless the sponsor or Asset Management Company (AMC) legally agrees to cover these returns. And this has to be clearly disclosed to investors upfront too.

So, who exactly is this Lena Bhai?

Most likely, he’s just another scammer preying on individuals like Durga. At least that’s what she realised when she read the news a few days ago about how SEBI is going after unregistered and unauthorised investment products just like Lena Bhai’s.

And that’s how she also stumbled upon what she was looking for – a new asset class that fits most of her requirements.

See, SEBI has finally given the green light to a new asset class that it had proposed back in July.¹ And now that everyone’s buzzing about it, she’s eager to find out what this is all about.

If you’re curious too, think of it as an investment product similar to mutual funds, but designed for those with a decent amount to invest ― just not enough to afford the high-end services of a professional portfolio management service (PMS).

See, mutual funds allow you to start investing with as little as ₹500 a month (or even ₹100 in some cases). It’s a great way to dip your toes into the investment pool. But the world of PMS is often out of reach for everyday investors, requiring a minimum investment of ₹50 lakhs or more. That’s a hefty sum reserved for the wealthy, who can afford tailored investment strategies across various assets like stocks, bonds and gold.

Now, picture SEBI stepping in with a solution designed for those of you who fall somewhere in between. That’s what this new asset class specifically targets ― investors with between ₹10 lakhs and ₹50 lakhs to invest. It’s for those who are willing to embrace a bit more risk than traditional mutual funds allow.

And just like mutual funds, this new asset class will have its structure, but with a slightly different approach. Instead of categorising funds based on the type of stocks like large-cap or small-cap schemes, it will instead be organised based on the different investment strategies fund houses employ.

Imagine a fund called Long-Short Equity Fund, for instance. This clever fund follows a strategy to profit from both rising and falling stock markets. So say if the fund managers believe the IT sector is set for a boom, they’ll buy stocks in that sector, going long. But if they predict that the banking sector will falter, they’ll bet against that sector and adjust the portfolio accordingly. This strategy allows them to benefit regardless of market conditions and gives investors the potential for gains in any scenario.

Then there’s the exciting prospect of an Inverse ETF/Fund. This type of fund is designed to make money when the market or index (a benchmark that tracks the performance of a group of stocks) it tracks declines. Essentially, it seeks returns that move in the opposite direction of the benchmark index. So, if the index drops, this fund could rise in value, offering a unique way to hedge against market downturns.

Until now, if you wanted access to such hedging strategies, you’d have to consider Alternative Investment Funds (AIFs), which typically required a minimum investment of ₹1 crore.²

But with these new investment strategies, you not only get a variety of options but also the flexibility to choose how often you want to withdraw your money. Whether it’s daily, monthly or even annually, you can customise the withdrawal frequency to fit your needs. This flexibility also helps fund managers manage liquidity, ensuring that they can buy or sell investments without putting undue restrictions on you as an investor.

Besides, the units of these investment strategies could even be listed on stock exchanges, especially for those with a withdrawal frequency of more than a week. This means that you could potentially sell your units on the exchange if the need arises, giving you even more options.

“Wow!”, you might think, “...SEBI really knows what it’s doing!” And you won’t be wrong if you think that way. SEBI is indeed making some clever moves.

But before we get too carried away, let’s also take a moment to delve into the inspiration behind these innovative ideas.

Actually, these types of alternative investment asset classes aren’t new. They’ve proven effective in other countries too. For example, in Europe, you have hedge fund-lite strategies, basically liquid alternatives wrapped in mutual fund like packaging.³ These strategies came up in response to the Global Financial Crisis in 2008, as investors looked for solutions to diversify their portfolios. And similar concepts have made waves in the US and Australia, with the goal of protecting everyday investors’ portfolios just like hedge funds do for the wealthy folks.

But here’s the thing. These liquid alternative funds haven’t exactly been stellar performers. To put things in perspective, in the 2010s, they averaged less than 2% in annual gains, falling short compared to most other types of investment funds.⁴ Sure, they didn’t lose money, but their returns were too low to justify their existence.

The challenge was that liquid alternatives often struggled to keep pace with the broader stock and bond markets. That’s because stocks and bonds have something called “beta”, a measure of risk. And they typically provide returns over time without requiring much skill to manage. On the flip side, liquid alternatives need skilled management to truly shine or do better than the average benchmark returns.

And if you look at the current mutual fund market in India, you’ll see that this could be a problem simply because just around 17% of total assets under management (AUM) are passively managed, while the rest are actively managed funds.⁵ And with this new asset class requiring more active management, it raises questions about whether it will be able to outperform benchmark indices as investors hope.⁶

There’s proof to back this up too. Professor M Pattabiraman of IIT Madras crunched the numbers to analyse the performance of actively managed mutual funds since 2006 and found that only about half, or even fewer, managed to beat the index more than 70% of the time.⁷

And since actively managed funds come with a higher expense ratio, meaning you’ll pay fund managers more to manage your money, this isn’t exactly the kind of track record you’d like to see as an investor. And while past performance might not be the best predictor of future returns, it’s certainly something to consider before diving headfirst into this new asset class, no?

So yeah, this new asset class could be a ray of hope for investors caught between the world of mutual funds and PMS. But it’s not a magical fix for higher or guaranteed returns.

As we wait to see if investors like Durga take the plunge, the question lingers ― will these new options deliver the results everyone is hoping for?

Only time will tell. Until then…

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Story Sources: SEBI [1], The Daily Brief by Zerodha [2], Morningstar [3] [4], Business Standard [5], Freefincal [6][7]

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