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New category of investors sign of maturing market

New category of investors sign of maturing market

The Securities and Exchange Board of India (Sebi) recently ushered in a new investor category—the accredited investor. Put simply, an accredited investor is one who qualifies on pre-specified criteria such as income and net worth; essentially a wealthy individual who is presumed to be well informed and hence granted access to investment opportunities that are beyond other retail investors.

In more evolved markets in the West and Asia, the well-informed, sophisticated/accredited investor category has triggered greater participation in and development of hedge funds and other complex alternative investment products. Given the role of accredited investors in broadening global financial markets, combined with pent-up domestic demand for such a category, it was only a matter of time before we saw the category break out in India.

This evolution should be looked positively with the stage of development of the Indian capital markets and maturity of the investor profile. Right from its formation in 1992, the board of Sebi has been entrusted with a role to protect the interests of investors. In the journey to protect investor interest, minimum investment threshold for high-risk products, including portfolio management services (PMS) and alternative investment funds (AIFs) were increased. Risk categorization was introduced in mutual funds and strong deterrents have been created to prevent mis-selling.

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As the financial landscape has expanded in breadth and depth, both sophisticated buyers of the products and the manufacturers, as also advisers, are keen on tailor-made financial products that serve investing needs in a defined risk management paradigm.

According to Sebi’s framework for accredited investors, individuals, family trusts, sole proprietorships, partnership firms, trusts and body corporates, Hindu undivided families (HUFs) can avail accreditation subject to financial parameters and pre-specified metrics (see table). It will be up to eligible subsidiaries of depositories and specified stock exchanges to certify accredited investors.

The biggest change Sebi’s proposed framework makes is in granting leeway to accredited investors in participating in investment products with flexibility on investment threshold, concentration norms, liquidity and fees than the one mandated in existing PMS and AIF norms. An important implication for PMS business is that a portfolio manager could be managing a portfolio of listed and unlisted securities for accredited investors with minimum portfolio size of 10 crore.

According to Sebi’s framework, central and state governments, funds set up by them, development agencies, qualified institutional buyers, category I foreign portfolio investors, sovereign wealth funds and multilateral agencies will be accredited investors and may not be required to obtain a certificate of accreditation.

Of course, like all innovations, this is not without peril. While the accredited investor stands to gain from unique investments offering higher returns and diversification, the (promise of) higher return comes at higher fees, as also higher risk from illiquid investments.

Going forward, the investor framework defining accredited investors can be a useful tool to distinguish investors who can invest and manage risk with minimal regulation. As this investment class and related product innovations evolve, the market regulator can take cues from more sophisticated trends in developed markets. The key to nurturing this segment and the related ecosystem lies in enhanced flexibility and liberalization of the regulatory framework governing it. This will make the AIF/PMS market more attractive to both domestic and foreign investors.

Prateek Pant is chief business officer, White Oak Capital Management.

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