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Alternative Investment Route to create wealth

PE and VC funds, though riskier, could be a good avenue when traditional assets have remained lackluster

With equities seeing red and debt being only marginally ahead of inflation, venturing into alternative assets like private equity (PE) and venture capital (VC) funds is worth considering. These funds, on an average, give 15-30 per cent returns, considerably higher than other investment vehicles.

While the world of PE and VC comes under the more sophisticated investment products, meant for those with high risk appetites, the investment philosophies they follow are not as complicated as one imagines. Traditionally, these funds invest in unlisted companies and start-ups. Once the company grows, they sell their stake to either another PE firm or in the public domain.

When it comes to PE and VC funds, with different funds being at different stages and having different underlying assets they have invested in, it is difficult to gauge the returns. Most funds claim to give returns of 20-25 per cent but actual returns are not publicly available. Domestic PE fund houses such as ICICI Ventures and IL&FS have been successfully running funds for some years and generating returns of 20-25 per cent. The Kotak India Real Estate Fund-I, which started in 2005 and had a seven year maturity period, has already paid investors back their entire principal, as well as given 15 per cent returns. VC funds offer higher returns, in the 25-30 per cent range. These funds are riskier, though, as the investment being made is at a more nascent stage of the company.

In PE and VC funds, investors typically invest in tranches and, in some cases, the payouts made by the funds are also in stages. However, with many of the funds providing returns on maturity, knowing how the funds are doing midway is difficult.

While PE and VC ticket sizes a few years before were in the `5-10 lakh range, the current entry point for most funds is 25 lakh and can go as high as `5crore. However, if the new takeover code guidelines issued by the Securities and Exchange Board of India get implemented, it could raise the minimum investment threshold to `1crore.

Investors usually get into PE and VC funds via their investment banker. Investors directly invest in PE projects as well, often as a group, pooling their money and investing. The advantage here is that investors can leverage the power of multiple investors, getting better deals and attractive valuations. Such investments are riskier than investing in a PE fund, wherein the investor pool is larger and the money collected is diversified amongst various projects and companies.

Another reason these funds make good investments in the current economic scenario is that they get better valuations and deals. In this sense, it is similar to investing in equities or in mutual funds, as a slowdown does provide opportunities as well. Also, with these funds having five to seven-year tenures, the slowdown is less of a concern, as the long investment tenure should ride out the short-term hiccups.

From an investor standpoint, when looking at such a high-risk asset class, going with people who are really good at what they do and understanding their industry and this business well is the key. Here, your banker plays a crucial role, as you would be investing on his recommendation.

Investments in consumer goods, health care and education sectors are on the rise, as these areas have witnessed a lot of asset building. PE investments in India grew 22 per cent last year.

One has to have patience and a long term appetite when investing in these funds. In a portfolio, while five to 10 per cent would be set aside for such investments, these days 15-20 per cent is worth investing in this asset class.

For Indian investors, consumer protection, far lower than that in the West, is an area of concern. A recent World Bank Group report placed India second-last in a list of 170 countries in terms of contract enforcement. "Protection issues for minority shareholders are impacting everyone and the structural bias and lack of protection in terms of payments, returns, inflows and exit clauses has led to investors being weary of such alternate investments.
 

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