The model is drawing keen interest, with 20 such funds having registered in GIFT City as of end July since regulations came in place in 2022. For perspective, India’s more established domestic ecosystem only has around 32 such funds till now, according to data from PMS Bazaar.
While the hub offers advantages, the talent pool to run such complex strategies in GIFT City remains shallow, which could be a concern.
A long-short fund aims to make returns by buying long and selling short positions, aiming to profit in rising as well as falling markets. Long-short funds mostly trade in derivatives using index futures or options.
Long-short funds in India, which fall under category III Alternative Investment Funds (AIFs), do not enjoy tax pass-through status and could potentially be liable to tax on their derivative income at the maximum marginal rate (MMR), which could be up to 39%, said Shikhar Kacker, a partner at Khaitan & Co.
On the other hand, the income tax law provides beneficial taxation for category III AIFs or long-short funds set up in GIFT City and they can potentially claim tax exemption on derivative income, Kacker added. However, such a fund should not have resident Indians as investors.
“Long-short funds in India have done decently and a majority have beaten benchmark (fixed income) on a gross return basis. However, the fees and taxes are a dampener. Post expense and tax, hardly any fund manager delivered a desirable outcome,” said a domestic long-short fund manager.
Long-short funds in India have given 3-22% returns in the last three years, as per PMS Bazaar. These are gross returns without factoring in expenses and tax. Long-only category III AIFs have given post tax and post expense returns of 8-23% in the last three years.
Since the capital markets regulator, the Securities and Exchange Board of India (Sebi) does not provide a breakdown of fund types within category III AIFs, the data has been sourced from PMS Bazaar, which compiles data from managers who disclose it to them.
Category III AIFs include long-only funds, long-short funds, and debt funds. Of these, long-only funds dominate with 102 in India, followed by 31 long-short funds, while debt funds remain limited to just 2. A long-only fund buys stocks or securities with the expectation their prices will rise, profiting only when markets go up. Commitments raised by category III AIFs were at ₹2,29,927 crore as of March end, as per Sebi.
A key reason for the traction in long-short funds is the availability of unlimited leverage for a GIFT City fund. “In a domestic India long-short fund, the fund can take leverage of not more than 2x of the fund size. The leverage in the case of a GIFT City long-short fund is unlimited,” said Nitin Pagar, head investor relations at Nubra.io, who helped set up Zanskar AIF, an absolute return fund, in GIFT City.
Pagar added that a domestic category III fund from India cannot freely short global indices over 25% of the fund, as it has to get approvals from Sebi. “There is no regulatory cap on overseas hedges, so a manager has the freedom to hedge an Indian portfolio by shorting offshore instruments and it can be done without the narrow 25% limit that binds onshore funds,” he added.
However, an inbound long-short fund in GIFT City can only raise money from non-residents. “So, if you are investing into India, then you can’t take money from Indians; it has to be NRI money, else it can be considered as round-tripping,” Pagar said.
More long-short funds are also coming up in GIFT City because of the tax certainty over other jurisdictions, say experts.
Funds set up in GIFT IFSC off Ahmedabad and investing in India provide onshore tax certainty over funds set up in the United Arab Emirates, Singapore or Mauritius, given the tax exemptions are a part of Indian laws, said Rohit Agarwal, the chief executive officer of funds business at Dovetail Capital.
In the case of jurisdictions such as Singapore or Mauritius, India has a double tax avoidance agreement (DTAA) with these countries. The agreement is meant to ensure that the same income is not taxed twice–once in India, where the income is generated, and again in Mauritius or Singapore where the fund is based.
What ’s next?
Even though long-short funds have an advantage over similar funds in India, there is some issue with minimum talent for such funds, say experts.
“The pool of professionals who can run a dedicated India long-only fund is limited. Over that, the ones who run India-focused long-short funds are even smaller, making it harder to scale the category,” said a person on the condition of anonymity.
Moreover, the talent for employing a long-short strategy focused on US equities or global equities is still less, said Sachin Sawrikar, founder and managing partner of Artha Bharat Investment Managers IFSC LLP.
He added that such hedge funds are still evolving in GIFT City partially due to the relative lack of domestic talent proficient in running such strategies since fund managers in India typically operate with limited international exposure with their focus primarily on the domestic markets and long-only equity strategies.
And when firms do identify strong managers, convincing them to relocate from developed jurisdictions such as Singapore or Luxemburg to GIFT City poses as another hurdle, the person who did not wish to be identified added.
Sebi had introduced a new category, the ‘Specialised Investment Fund (SIF)’, in February, where the minimum ticket size is ₹10 lakh. Mint had reported that long-short funds launched under this category will lead to investors preferring SIFs over long-short AIFs. This was mostly because of a tax advantage SIF investors would have over long-short AIFs, plus a lower ticket size.
