What is SIF (Specialized Investment Fund) all about?
Updated: Aug 24
SIF schemes are allowed by SEBI to invest in the underlying securities from asset classes of Equity, Forex, Commodity and Fixed-income as well as their derivatives (Futures & Options) in order to deliver better volatility-adjusted returns. In SIFs, unhedged short positions are allowed by SEBI up to a limit of 25% of the portfolio value to help generate returns and reduce downside during bearish markets. Various Options derivative strategies along with the timing expertise of the fund managers, are dynamically employed to generate additional income in all types of market cycles, be it during bullish, bearish or sideways conditions. Fund managers further define the ranges of gross and net exposures that they will take for each asset class in their SIF schemes, thereby creating a multitude of alternatives suitable for different investor profiles and different time horizons.
Background
Derivative strategies are not new and have widespread adoption globally, especially in developed economies, where they have been extensively used for over a century for hedging and income generation. It was in the year 1865 that the Chicago Board of Trade (CBOT) listed the first Exchange-traded Futures contract in the US. In India, the first Exchange-traded derivative was launched over 2.5 decades back in the year 2000. At present, SIFs are launched by the same AMCs that offer you Mutual Funds, and are subject to the same rigorous SEBI compliance and transparency regulations that are applicable to Mutual Funds. SIFs operate under a legal Trustee structure similar to that of Mutual Funds. What this means for investors is that they themselves are the beneficiaries of all units held under the Trust framework with AMCs. So, any creditor of the AMC cannot lay a claim on these investments for any reason. This is the main reason why you have never heard of any AMC defaulting on redemptions to investors from the time SEBI has taken up regulation of this industry around 3 decades back.
Many of the experts in the SIF fund management teams are those who have been running similar derivative strategies successfully for years in PMS (Portfolio Management Schemes) / AIF (Alternative Investment Funds) schemes earlier in India itself. The first SIFs were launched last year and are now close to completing their first year of performance. SIFs have had an exponential trajectory of growing interest followed by huge investments, especially by HNIs as you may have read in the recent articles published by The Economic Times and Mint.
What are the pain points of HNIs and why are SIFs turning out to be such a compelling investment proposition for them? The main reasons can be attributed to these points:
Professional wealth management instead of DIY investing
When these individuals started out their careers and had no family responsibilities, they had the time and appetite to invest their smaller savings into more volatile investments including direct equity and even derivatives. Some may have had beginner's luck and made some returns even without having a systematic rules-based, research-backed strategy. But as they progressed in their careers and amassed wealth over time, they became more cautious in their investment choices as small mistakes can leave a big impact on their wealth. They then sought expert guidance and preferred professional management of their investments with well-defined processes and frameworks, especially when it comes to equity and derivatives investments. After doing this, they are better able to concentrate on their careers taking on increased responsibilities at higher positions, and any spare time that they have, they prefer to spend as quality time with their families and leisure activities.
Prioritizing wealth preservation over wealth creation
During their journey, as the accumulated wealth increased and they became more cautious, they started allocating a large portion to conservative investments to provide stability to their portfolio, even though these may give no real inflation-adjusted returns. At a certain stage in life, they understandably started prioritizing capital preservation rather than chasing high growth. Initially, the conservative part of the allocation was done primarily to Debt instruments like Bank Fixed deposits and Corporate bonds. These debt instruments have progressively given lower and lower returns as compared to earlier, and are taxed as per the investors tax slab every year irrespective of the holding period. Currently, the marginal tax rate for HNIs goes up to 42% including surcharge on tax and the cess depending on their income slab! So eventually, they moved to tax-efficient alternatives like arbitrage funds which give debt-like returns and have the advantage of LTCG tax rate of only 12.5% as well as the benefit of deferred taxation only at the time of redemption. And now, thankfully we have conservative SIF Long-Short Hybrid category schemes which are of great interest to them, as these offer the potential of enhanced returns at low volatility with the same tax benefits as arbitrage funds.
Preferring less volatility and tax-efficiency for growth
For the aggressive parts of their allocation planned for a longer time horizon, much of their investments went to PMS and AIF Category 3 schemes. Now, with SIF Long-Short Equity category as another alternative available with similar strategies, HNIs are interested in comparing the pre-tax returns required in each of these alternatives for a given in hand post-tax return. The applicable tax structure for PMS and AIF is ETE (Exempt-Taxable-Exempt), while for SIF it is EET (Exempt-Exempt-Taxable). Basically, this means that any net profit by PMS and AIF is taxed every year and that too at a higher tax rate typically, while for SIF it is taxed only at the time of withdrawal at the lower LTCG tax rate. So, for an investor with a particular post-tax return expectation, he has to be very careful if he is going in for PMS or AIF as the bar has to be set much higher when compared to SIF, just to offset the tax impact. Are there any PMS and AIF funds which have given high enough returns over the long term to competitively offset the tax impact? Yes, there are, especially in funds that follow concentrated Long-only strategies. But then, HNIs would also like to look at the volatility and maximum decline of these Long-only funds when compared to that of SIF Long-Short funds, before they make an investment decision. SIFs can potentially address these points as they are designed to navigate market volatility smoothly and offer superior downside protection when compared to Long-only strategies.
Next steps
As per SEBI regulations, the minimum ticket size for investing in SIFs is ₹ 10 lakhs per investor per AMC. So, if you have a huge amount simply kept aside in Fixed deposits or Corporate bonds, it is a good time to explore SIFs to enhance post-tax returns in a comfortable way. To start off, a small allocation may be made to a suitable conservative SIF scheme. Within the popular SIF Long-Short Hybrid category and SIF Long-Short Equity category, there are various schemes for conservative to aggressive investor preferences across various investment time horizons starting from 2+ years to 7+ years. By leveraging a decade of my understanding and experience of trading F&O full-time, and after closely studying SIF strategies, their benefits and their potential, personally I am of the view that SIFs will become the preferred way to invest for HNIs in the near future! Of course, before investing in SIFs, it is important to read the Fund Factsheets, Investment Strategy Information Documents and other relevant scheme-related documents apart from taking professional guidance. A proper understanding of each scheme's workings is needed because even within the same category, SEBI has given enough leeway to Fund Managers to offer SIFs with completely differentiated strategies. To know more about SIFs, what they offer and understand their suitability for your specific requirements, reach out to me at +91 7483255790 to set up a 1-to-1 no-pressure discussion.
Ishwar Mahadev Murgodi
AMFI Registered SIF Distributor (ARN-330744)
