EMERGENCE OF A NEW ASSET CLASS

What You Need to Know about SEBI’s Proposed Alternative Investments

Charles Ponzi died in 1949, but his infamous legacy refuses to die 75 years later. Ponzi schemes are fraudulent schemes touted as investment alternatives that promises high returns to investors by employing secret strategies. The hidden motive is only to attract fresh investments by delivering some returns to a few early investors and then disappearing with investors’ money.

So, what’s the connection between Ponzi schemes and the new asset class proposed by SEBI? Understanding Ponzi schemes is crucial in evaluating this new asset class’s potential risks and benefits. The connection lies in the fact that SEBI’s regulations are designed to prevent such fraudulent schemes from operating in the market as alternative investments, making the new asset class a safer investment option.

The Securities Exchange Board of India (SEBI) is leading the battle against Ponzi schemes. This reassuring fact instils confidence in the proposed new asset class consultation paper they published on their website and invited public comments.

So far, a similar scheme is available as a Portfolio Management Scheme (PMS) for investors with a minimum corpus of Rs. 50 lakhs. The exciting news is that the idea is to tailor a new product by combining existing mutual fund schemes with PMS and making it accessible to more investors, including you.

Let’s delve into the potential benefits of the new asset classes, sparking optimism and hope for the investment opportunities it may bring.

They have proposed two products (alternative investments) under the scheme.

THE LONG-AND-SHORT EQUITY FUND

Imagine purchasing a rare painting, artefact, or property in an upcoming locality. You intend to hold onto it long-term, anticipating its value to appreciate before you sell it for a profit. This is the essence of the ‘long-selling’ strategy of investment.

This is precisely how the ‘long-selling’ investment strategy works in the stock market. How does it help?

  • Compounding benefit
  • Risk mitigation as risks spread over the long term
  • Tax efficiency as taxes on long-term capital gains (LTCG) are less.

This operates on a bullish mindset that prices will rise in the long term.

Direct equity offers all these benefits, so how does including long-selling help a mutual fund? It balances the risk of short-selling.

You find a suitable buyer for a borrowed black umbrella and sell it for Rs.150/-. But remember, the umbrella does not belong to you and needs to be returned to its owner.

Many people are disposing of black umbrellas as the monsoon is nearing an end, and they would like to buy a stylish one for the next season. The price falls due to reduced demand, and you buy an identical piece for Rs.100/- and return it to the owner.

Congratulations on making a clean profit of Rs. 50/-!

This is how a short-seller operates. It pays a fee to the broker who owns the stocks and makes a more significant profit from the deal.

Short-sellers work on a ‘bearish’ assumption that prices will fall. If prices rise, they risk a margin call —they will have to pay the cost to the shareholder.

How will the proposed long-and-short equity fund work?

It will combine the above two strategies to maximise the returns. The minimum investment is proposed to be a million (Rs. 10 lakhs), making it accessible to more prominent investors.

REVERSE EXCHANGE-TRADED FUND (ALTERNATIVE INVESTMENTS)

We know that returns in index funds move with the chosen stock index, with minimal intervention from the fund manager. It works well in a bull phase when markets are moving upwards.

But what will happen to the investors in a bear phase when the indices are dipping?

ETFs (exchange-traded funds) are passively managed and typically mirror an index. Their performance directly reflects the index movement.

If an inverse ETF rises during a downturn, the underlying index falls. ETFs don’t earn in the same way as mutual funds; their value depends on market dynamics.

Inverse ETFs are alternative investments that propose to hedge the risk of a downturn by moving the value of the ETF upwards when the graphs go south.

How does a mutual fund compensate itself for the loss here? It earns through various mechanisms.

  1. Expense Ratio: Mutual funds charge an expense ratio to cover management fees, administrative costs, and other expenses. This fee is deducted from the fund’s assets regardless of market conditions.
  2. Securities Lending: Some mutual funds engage in securities lending. They lend securities (like stocks) from their portfolio to other market participants (such as short sellers) and earn a fee in return. Even during a downturn, this income continues.
  3. Dividends and Interest: If the mutual fund holds dividend-paying stocks or interest-bearing bonds, it receives periodic payments. These income streams persist regardless of market fluctuations.
  4. Rebalancing and Buying Opportunities: During a downturn, mutual fund managers may rebalance the portfolio by buying undervalued assets. If the market eventually recovers, these purchases can lead to gains.

WHO IS QUALIFIED TO OFFER NEW ASSET CLASSES?

Mutual funds with a total AUM of more than Rs.10,000 crores and those without any penal action for the last three years will be allowed to offer the new asset classes.

Are we ready for the revolution?

Consult a financial expert to learn more.

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