Hedge funds, such as our flagship long-short product, are designed to generate higher risk-adjusted returns for investors compared to traditional investment vehicles. Unlike mutual funds, hedge funds employ complex trading strategies, leverage, and derivative instruments to achieve their performance goals. The primary objective is to outperform respective benchmarks while mitigating risk.
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Who Can Invest in Hedge Funds?
Hedge funds fall under Category III Alternative Investment Funds (AIFs) in India. Given their sophisticated strategies and inherent risks, they require a minimum investment of ₹1 crore per investor. This exclusivity makes them accessible only to High-Net-Worth Individuals (HNIs) and institutional investors.
Understanding Hedge Fund Taxation
As a Category III AIF, hedge funds face a 39% tax rate for individuals in the highest income bracket. This taxation structure significantly impacts net returns. While the long-short strategy targets gross returns of 14%-16%, the post-tax and post-fee returns range from 7%-9%. Despite this, hedge funds aim to outperform traditional fixed deposits or bond funds by 200-300 basis points.
Types of Hedge Funds and Their Strategies
Hedge funds employ diverse strategies to achieve their risk-adjusted returns. Below are some key hedge fund categories we manage, each with unique asset allocation models and performance objectives.
1. Debt-Oriented Hedge Fund
- Objective: Generate absolute returns with lower volatility than the stock market.
- Strategy: Uses a long-short approach to create a portfolio with a low correlation to conventional asset classes.
- Expected Gross Returns: 14%-18%.
- Post-Fee, Post-Tax Returns: Around 7%-9%.
- Asset Allocation:
- Government Securities (G-Secs)
- Bonds
- Index options contracts
- Special situations like block trades
2. Actively Managed Equity-Oriented Hedge Fund
- Objective: Deliver high alpha while maintaining a lower beta.
- Strategy:
- 85% allocation to a long-only portfolio for aggressive equity exposure.
- 15% allocation to a long-short portfolio to reduce beta risk.
- Performance Goal: Outperform Nifty while ensuring a better risk-adjusted return.
3. Passively Managed Equity-Oriented Hedge Fund
- Objective: Similar to the actively managed equity fund but with passive investment allocation.
- Strategy:
- 70% allocation to long-only portfolio with passive investing.
- 30% allocation to long-short portfolio to hedge risk and ensure stability.
What is a Long-Short Strategy?
A long-short strategy involves predicting market movements and identifying companies that will benefit or suffer due to market shifts. This strategy enables hedge funds to generate returns in both bull and bear markets.
Example of a Long-Short Trade:
- If an investor predicts oil prices will surge to $100 per barrel, they might execute the following trade:
- Go Long on ONGC: Since ONGC benefits from rising crude prices.
- Short Asian Paints: Since Asian Paints incurs higher costs due to expensive crude oil (a key input in paint manufacturing).
- By executing such trades, hedge funds capitalise on sectoral trends and market inefficiencies to generate consistent returns.
Conclusion
Hedge funds offer an exclusive investment avenue for HNIs and institutional investors who seek higher returns with controlled risk. While they come with higher tax implications, the ability to utilise long-short strategies, derivatives, and asset diversification provides a strong case for them over traditional investment options. Whether seeking debt-like stability or aggressive alpha generation, hedge funds present a compelling opportunity for those who understand and can tolerate the associated risks.
