No Alternative to ‘Alternative Investments’
For decades, portfolio construction followed a simple script: equities for growth, bonds for income and stability, with an allocation to gold or real estate for further diversification. It was the bedrock of 20th century wealth management. But as more economic value has shifted outside public markets, that framework, while still relevant, is no longer sufficient on its own. A new layer has moved from the periphery to the centre: alternative investments.
What are alternative investments?
Traditionally, ‘alternative investments’ refer to assets outside listed equities, fixed income, and cash. This includes private equity, venture capital, hedge funds, and real assets such as infrastructure, commodities, and more esoteric instruments like structured credit.
India’s regulatory framing is distinct. Under AIF regulations, alternatives flow through Category I (venture capital, SME, infrastructure), Category II (private equity, private credit), and Category III (long-short or hedge fund-like strategies). We are also seeing the emergence of Specialised Investment Funds (SIFs), which offer hedge fund-like features with Tax-efficient structures and lower entry thresholds.
Further, Indian residents can allocate up to USD 250,000 per family member annually through the Liberalised Remittance Scheme (LRS), opening a window to global alternatives. While access and minimum ticket sizes remain a hurdle, options are expanding with a 50 per cent compounded annual growth in AIF commitments over the past decade.
Features and payoffs
The differences across alternatives are best understood in return, risk, and liquidity outcomes. Private equity and venture capital provide access to companies before they list, typically targeting a net IRR of 4-5 per cent above public markets in exchange for illiquidity. Private credit offers higher yields, often with structural protections absent in listed debt.
In both cases, manager selection is a crucial component. The return gap between top- and bottom-quartile private equity managers routinely exceeds 15 percentage points annually. Unlike public markets, where information is abundant and pricing corrects quickly, private markets offer no such discipline. Choosing the wrong manager is not just marginal; it can materially alter the calculus.
Infrastructure and real estate, whether through direct exposure or vehicles like InvITs and REITs, introduce longer-duration, income-generating assets. Gold occupies its own category, part monetary hedge, part cultural artefact, and has historically provided meaningful protection during equity drawdowns.
The Case for Alternatives: Three Pillars
The argument for inclusion rests on three considerations:
- Enhanced Risk-Adjusted Returns: Private equity captures an illiquidity premium, while private credit offers yields that compensate for complexity. Most alternatives have lower correlations with traditional assets and among themselves, particularly over shorter horizons.
- Diverse Payoff Profiles: A venture investment behaves differently from a listed Mid-Cap stock, just as structured credit differs from a plain-vanilla bond. Returns, holding periods, liquidity, and income streams can differ widely among different instruments.
- Capturing Value Creation: With global private-markets AUM now exceeding USD 15 trillion, the centre of gravity for value creation has shifted to the private domain. Many high-growth companies stay private longer, and waiting for an IPO often means missing their most explosive growth phase. Examples like Anthropic, OpenAI, and SpaceX show how billions in private capital are deployed while these companies scale without the constraints of public-market scrutiny.
The Constraints that Matter
These benefits come with real trade-offs. Illiquidity is not a minor inconvenience. Capital locked up for seven to ten years in an underperforming vintage is a genuine cost.
Further, the ‘democratisation’ story remains early in India. The gap between what institutions can access and what is available to individual investors is still material. Investors must also account for tax: the post-tax yield on certain AIF categories can differ significantly from listed securities. Investors should calibrate expectations to where the market is, not where it is heading.
Yet these constraints are also the source of the opportunity. Illiquidity persists because it is inconvenient, and investors willing to accept that inconvenience are historically compensated for doing so.
A Portfolio Question
The ‘Endowment Model’ pioneered by institutions like Yale demonstrated decades ago that a 15-20 per cent allocation to alternatives can reduce drawdowns and moderate volatility while maintaining or enhancing long-term returns. The effect may be incremental in any single year, but it compounds over cycles.
As Indian wealth deepens, the question is no longer whether alternatives belong in portfolios, but how thoughtfully they are incorporated, and with which instruments and managers. In a world where public markets capture only part of economic value, investors who remain confined to them may find themselves well diversified, but not quite as well positioned.
Disclaimer: The opinions expressed above are of the author and may not reflect the views of DSIJ.