What are Hedge Funds in the Indian Stock Market?
A hedge fund pools money from private investors and is managed by professional managers who use strategies like leverage and non-traditional assets to seek higher returns. These funds are typically risky, require high minimum investments, and are generally accessible to wealthy investors.
What is Hedge Fund in India?
Hedge funds raise capital from accredited investors and institutions to generate high returns. They achieve this by investing in diverse assets and employing various hedge fund risk management strategies.
SEBI introduced hedge funds in 2012 under the SEBI Alternative Investment Funds Regulations. These funds are classified as category III AIF (Alternative Investment Funds) and are still growing, requiring more regulation. Compared to global markets, hedge funds in India are still in their early stages.
Hedge funds are usually structured as limited partnerships and managed by professional fund managers. These funds typically use different investment strategies compared to mutual funds, with varying structures and regulatory frameworks.
History of Hedge Funds
The hedge fund industry began in 1949 when Alfred Winslow Jones created a flexible equity fund that allowed both long and short positions in securities, aiming to boost returns and reduce market exposure. He also utilised leverage to enhance hedge fund performance.
In the 1950s, other incentive-based partnerships like Warren Buffett’s Buffett Partners and Walter Schloss’s WJS Partners emerged. While these weren’t traditional hedge funds (as short-selling wasn’t a focus), they are considered hedge funds by today’s broader definition. Today, the term ‘hedge fund’ includes many types of funds with various risk exposures.
How Do Hedge Funds Work?
Hedge funds use various strategies to invest in securities and assets, including derivatives like futures and options. These hedge fund strategies carry higher risks but also offer the potential for high returns.
Here’s how hedge funds work in India:
- Derivatives: Hedge funds invest in futures and options (F&O) to profit from price changes in underlying assets.
- Futures: Requires buying or selling a stock at a set price, date, and time.
- Options: Allows buying or selling without a mandatory commitment.
- Leverage: Hedge funds borrow money to invest more, increasing both potential returns and risks.
- Short-Selling: Hedge funds make a profit when stock prices fall by selling borrowed stocks and repurchasing them at a lower price.
- Hedging: A hedge fund is an investment fund that pools capital from accredited investors to invest in a variety of assets.
What are the Key Characteristics of Hedge Funds?
Here are the features of hedge funds in India.
- Eligibility: Top hedge funds in India are only available to accredited investors who meet minimum income or net worth requirements. The minimum amount required to start a hedge fund is ₹20 cr., as they are high-risk investments.
- Fees: Hedge funds charge high fees, including management fees (percentage of the fund’s assets) and performance fees (percentage of profits).
- Lock-in: Investors may have a lock-in period, during which they cannot withdraw their money. This can be a few months to a few years.
- Strategy: Indian hedge funds employ various approaches, including an arbitrage strategy for long/short equity, event-driven funds that capitalise on corporate events and macroeconomic trends, to generate high returns.
Types of Hedge Funds
Here are the four main hedge fund types in India:
- Global Macro Funds: These funds profit from market fluctuations by leveraging macroeconomic factors like inflation rates and other financial conditions.
- Relative Value Hedge Funds: These funds capitalise on the price differences between related securities to generate higher returns.
- Activist Hedge Funds: These funds invest in hedge fund companies in India that make significant changes, such as cost-cutting or asset restructuring, in response to diverse demands.
- Equity Hedge Funds: These funds invest in global or domestic stocks and protect against market downturns by selling overvalued stocks or stock indices.
What are the Different Strategies of Hedge Fund Investing?
The top strategies of hedge investing that hedge fund companies in India follow are:
- Long or Short Equity: A short or long equity hedge fund strategy seeks to generate returns by taking long and short positions in individual stocks.
- Global Macro: The global macro strategy uses macroeconomic factors. To invest in various assets, such as interest rates and currency exchange rates.
- Event-driven: Investments that are made in companies that are undergoing significant corporate events, such as mergers, acquisitions, and bankruptcy.
- Quantitative: This strategy uses mathematical models and algorithms to identify investment opportunities.
What is the Hedge Fund Structure & Fee Model?
Hedge funds employ a standard “2 and 20” fee system today. The fee structure comprises two components: a management fee typically below 2% and a performance fee of 20%. Therefore, to invest in these funds, the minimum investment fund required is ₹1 cr per investor, while the entire fund must have a minimum corpus of ₹20 cr.
What are the Risks and Returns in Hedge Funds?
- Higher Risk Means More Regulation: Hedge funds in India are riskier, leading to more stringent regulations. Moreover, they need to register with SEBI under AIF regulations.
- Different Transparency & Less Regulation: Hedge fund transparency and reporting requirements are different from other funds. SEBI monitors hedge funds, but lower regulatory oversight makes it riskier.
- Risk-Return Tradeoff & Complex Strategies: Risk and return are closely related. The hedge funds can give high returns of around 15% per annum. But these returns come with higher risks due to complex strategies, leverage and limited regulatory oversight.
How are Hedge Mutual Funds Taxed?
Hedge mutual funds, categorised as Category III AIFs (Alternative Investment Funds) in India, are subject to tax on their gains or income at the fund level. This hedge fund taxation differs from pass-through vehicles, where taxes are paid by investors. Hedge fund taxes are deducted before profits are distributed, affecting the final returns for investors.
| Income | Tax Rate |
| Annual earnings exceeding ₹5 cr. | 42.74% |
| Annual earnings below ₹5 cr. | 30% |
| Dividends | 15% |
Note: Dividends are subject to a 15% tax if distributed by domestic companies, but rates may vary based on other factors.
Who Should Invest in Hedge Funds?
Hedge funds are typically for accredited investors, which include high net worth individuals (HNIs), institutional investors, banks, insurance companies and pension funds. These investors have substantial capital, a higher risk appetite and access to professional advice.
The minimum investment in hedge funds is generally ₹1 cr., with the total fund corpus being above ₹20 cr. Due to these high investment thresholds, hedge funds are not considered for the masses.
Hedge funds come with high risk due to their investment strategies and less regulatory oversight, and are also subject to tax considerations.
The following types of investors may consider hedge funds:
- High Net Worth Individuals: May invest in hedge funds for portfolio diversification with a higher risk appetite.
- Institutional Investors: May allocate capital to hedge funds as part of their investment strategy for long-term growth and diversification.
- Banks and Insurance Companies: May use hedge funds to manage risk and potentially enhance returns across their portfolio.
How are Hedge Funds Different from Mutual Funds?
Below is the table presenting a clear side-by-side comparison of hedge funds and mutual funds, highlighting their key differences in regulation, investor access, strategies, fees, liquidity, transparency, diversification, and tax treatment.
| Feature | Hedge Funds | Mutual Funds |
| Regulation | SEBI AIF Category III rules – lighter disclosure, private placement | SEBI (Mutual Funds) Regulations – strict disclosure (daily NAV, monthly portfolio), trustee oversight |
| Investor Eligibility | Only HNIs (₹1 cr+), QIBs | Anyone (retail, NRIs, HUFs); SIPs from ₹500 |
| Minimum Investment | ₹1 cr+ upfront; corpus ≥ ₹20 cr. | ₹500–₹5 000; SIPs allow small periodic investments |
| Strategies | Unconstrained: leverage, short-selling, derivatives, arbitrage | Defined mandates (equity, debt, hybrid); limited derivatives for hedging |
| Leverage & Short Selling | Widely used to boost returns or hedge | Generally restricted or prohibited |
| Liquidity | Low: 1–3 year lock-ins, quarterly/half-yearly redemption windows | High: open-ended redeemable daily; some closed-ended with defined exit windows |
| Fee Structure | “2 & 20”: ~2% management + ~20% performance fee | Expense ratio only (0.5–2% of AUM); no performance fee; SEBI caps TER by fund type |
| Transparency | Limited: private placement memoranda; quarterly or less frequent NAV and portfolio disclosures | High: daily NAV, monthly portfolio statements, quarterly/annual reports |
| Diversification | Concentrated bets; non-traditional assets allowed (real estate, commodities) | Must follow SEBI diversification limits across sectors, issuers, instruments |
| Tax Treatment | AIF Category III taxed at ~42.74% on gains >₹5 cr; carried interest taxed as income | Pass-through: Equity STCG (≤12 m) at 15%; Equity LTCG (>12 m) at 12.5% above ₹1.25 L; Debt gains at slab rate or 12.5% no indexation |
What are the Things to Remember Before Investing in Hedge Funds in India?
Here are some of the factors to consider while investing in hedge mutual funds in India.
- Read the Hedge Fund’s Documents and Agreements: You can read the documents as they contain the fund’s strategies, the location of the fund, and the risks anticipated by the investment.
- Understand the Risk: Since hedge funds in India are highly volatile, you may consider all the risks involved as a hedge fund investor.
- Expensive: With a minimum ticket size of ₹1 cr, which may be high for many investors, it is important to carefully evaluate whether this investment aligns with your financial capacity and objectives.
- Hedge Fund Fees: These fees can reduce your hedge fund’s returns, so it might get essential to understand them before you invest.
What is the Difference Between Hedge Funds and Other AIFs?
While multiple Alternative Investment Funds (AIFs) share some similarities, such as accepting investors’ money and investing it collectively, they also have unique characteristics that set them apart from hedge funds.
Let’s have a look at the following table and explore more about hedge funds vs mutual funds and other AIFs:
| Feature | Hedge Fund | Venture Capital | Private Equity | Commodity Pool |
| Investment Objective | Generate absolute returns, regardless of market direction | Provide capital for early-stage companies with high growth potential | Acquire and manage private companies | Invest in commodities |
| Investment Strategies | A diverse range of strategies to seek high returns and mitigate risks. | Invest in early-stage companies through seed rounds, venture rounds, and later-stage rounds | Invest in private companies to provide capital for expansion or buyouts. | Invest in commodity futures contracts to gain exposure to commodity markets. |
| Risk Tolerance | High | High | High | High |
| Liquidity | Illiquid | Illiquid | Illiquid | Illiquid |
| Fees | High | High | High | High |
| Regulation | Less regulated | Less regulated | Less regulated | Less regulated |
| Investors | Accredited investors | Accredited investors | Accredited investors | Accredited investors |
To Wrap It Up…
In conclusion, the structure of hedge funds in India is complex. Moreover, these funds are generally considered to carry higher risks. Therefore, hedge funds may offer opportunities for returns, but they are typically suited for accredited investors with substantial capital and a higher risk tolerance. Investment in such funds should be evaluated carefully as per the individual financial goals, risk capacity, and suitability for the investor. You may also consult a financial advisor before making any decision to invest in hedge funds.
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Frequently Asked Questions About Hedge Funds in India
Hedge funds encompass investments in equity, commodities, currencies, derivatives and real estate. These funds, which are lightly regulated by SEBI, make money through a 2% management fee and a 20% performance fee.
Hedge funds, as investment vehicles, can sometimes outperform other options by using strategies like short selling and leverage to boost returns.
Mutual funds vs hedge funds are both pooled investment vehicles but differ in strategy, fees, investor qualifications and liquidity. Hedge funds use diverse, actively managed strategies with higher fees and often require accredited investors. At the same time, mutual funds offer simpler strategies than hedge funds, lower fees and greater liquidity to a broader investor base.
Hedge fund examples are Motilal Oswal’s offshore hedge fund, Munoth Hedge Fund, Quant First Alternative Investment Trust, IIFL Opportunities Fund and India Zen Fund.
Karthik Sarma is an Indian hedge fund billionaire. As of June 2023, his net worth was estimated at US$2.9 bn. Sarma earned a bachelor’s degree from the Indian Institute of Technology Madras and a master’s from Princeton University.
To start a hedge fund in India, you need to:
– Register as an investment manager with SEBI
– Raise a minimum corpus of ₹20 cr from accredited investors
– Hire a team of experienced investment professionals
– Develop and implement a hedge fund investment strategy
The main risks include hedge fund liquidity issues, market fluctuations, leverage, regulatory gaps, and manager dependence, as hedge funds are less regulated and may have long lock-in periods.
In India, hedge funds are regulated under the Alternative Investment Fund (AIF) regulations by SEBI. However, hedge funds are subject to different regulatory frameworks, offering more flexibility but also introducing higher complexity and potential risks.
In India, starting SEBI hedge funds requires registration under the Alternative Investment Fund (AIF) regulations. There are specific guidelines on hedge fund legal structure, investment strategies, and disclosure requirements that must be followed.
