Why Alternative Investment Funds Could Outpace All Other Asset Classes

AIF commitments surge 3.6 times since FY20, promising higher returns and wider investor participation.

​For the year 2024, the global gross domestic product (GDP) was about USD 114 trillion. Total assets under management (AUM) of the asset management industry worldwide were around USD 128 trillion (112 per cent of GDP). Of this, private markets (comprising PE, VC, real assets, hedge funds, private credit, et al), constituted USD 24 trillion, translating to about 21 per cent of GDP.

​On the other hand, India’s GDP for 2024 was USD 4 trillion. Total AUM of the asset management industry (mutual Funds, PMS, alternatives) was USD 1.4 trillion (35 per cent of GDP). Of this, private markets (comprising commitments to all alternative investment funds), constituted USD 0.15 trillion, less than 4 per cent of GDP.

​No doubt, private markets are more than just AIFs, but that’s beside the point. What this column is attempting to establish is that on the long runway ahead for our asset management industry, AIFs could grow meaningfully faster than the overall pie.

​Past data bears this out well. Since the time Sebi came out with the AIF regulations in FY13, total commitments to AIFs have grown nearly 940 times at an astonishing compound annual growth rate (CAGR) of 77 per cent.

​However, let’s get serious and look at more recent data. Comparing FY20 numbers with FY25, we see that the total commitments to AIFs have grown from Rs 3.5 trillion to Rs 13.5 trillion, a fantastic 3.6 times in five years with a CAGR of 30 per cent. This compares with 22 per cent growth in AUMs for MFs and 16 per cent for PMS over the same period, albeit on a much bigger base.

​But then, do remember that both MF and PMS AUMs are also impacted by market performance and an increase (or decrease) in valuations. AIF growth, on the other hand, is being measured here only via fresh commitments and hence is even more credible. This is thanks to the over 1600 registered funds with more than 140,000 investors already within the AIF ecosystem. Recent data shows continued enthusiasm with more than 30 new fund applications being filed monthly, and nearly two-thirds commitment coming from domestic investors.

​All this supports the thesis, but what’s next? How could AIFs grow another 5-10 times from here in the next five to ten years? There is not a single answer, but like any other investment product, a significant part of investor behaviour is driven by potential profits or returns and on that count, AIFs seem to be stacking up.

​Returns
​As per a publicly available benchmark developed by Crisil-Oister Global, as of March 2024, AIFs comprising VC and PE funds (starting FY13 vintage) generated an alpha of 5.39 per cent over BSE Sensex TRI on a post-expense, pre-carry (profit share) basis, with significantly lower volatility (some benefits of being unlisted!). The alpha on a post-carry basis would still be meaningful to compensate for the illiquidity inherent in such funds.

​Distributions
​And this is not merely some future projection, from the same dataset, AIFs that had started making distributions (~80 per cent of the total) had already returned on average 0.57 times of investor commitments, with the top quartile funds having returned an average 1.67 times so far. So far, so good!

​Access
​Yet another critical factor is the unique investment universe that only AIFs can open for investors. There is no other similar structure (regulated, actively managed, diversified) available for investors wishing to participate in the buoyant domestic start-up scene or invest in emerging businesses. Whether it is AI, biotech, defence, urban services, consumer brands or fintech companies, AIFs are a key provider of capital to businesses across life stages. Early investors in AIFs have already seen the rewards of secondary exits and public listings.

​When it comes to other investment categories, including private credit, real estate, yielding infra and real assets, again, it is only AIFs that provide a unique regulated platform for investors to participate institutionally.

​Regulations
​On the regulatory front, Sebi has proactively managed the environment, keeping investor interest as well as industry evolution as guiding lights. Recent moves around accredited investors and fund dissolution mechanisms are some good examples. Undoubtedly, regulations have become more complex than when we started in 2012. But to be fair to the regulators, we’ve also been in uncharted territory, the market has grown exponentially, and newer challenges have emerged in tandem with fund lifecycles. One may have a few quibbles here & there on this, but who said life is perfect?

​Given all the above, it is no wonder that investors are increasingly comfortable making a meaningful allocation to AIFs as part of their investment portfolios.

​Now What Else Can India Do?
​Greater domestic institutional participation, from banks to insurance companies to pension and provident funds, is sorely needed. We need a lot more evolution on this front. Perhaps fund-of-funds can be a way for some of these institutions and their regulators to enhance comfort. Another sophisticated investor category, Family Offices, is already a growing participant that could provide the lead for individual investors to follow.

​Apart from performance, fund managers must aim to get to the next level with respect to governance, transparency and investor relations. More industry-wide performance benchmarks could be made available to provide greater disclosure and comfort to investors. Importantly, a well-developed, transparent secondary market could allay investor fears of illiquidity and long lock-ins.

​Sustained performance along with further industry evolution could be very helpful in ensuring the continued growth of AIFs in India over the long term. It is incumbent upon all the stakeholders to make it happen.​