Introduction

The Indian investment market is edging on the alternate path of investment with the successful flight of Alternative Investment Funds (AIFs). With the evolving landscape of investments, AIF can be the cherry on top of your portfolio cake.

However, you should check the performance of the AIF before investing. As an investor, your first question would be how to evaluate such AIFs based on their performance to decide whether you should invest in a particular AIF.

To prioritize your concerns as ours, in this blog, we discuss how to evaluate the performance of alternative investment funds.

Let’s evaluate!

Performance of AIFs

Alternative investment funds like SME Funds, Venture Capital Funds, Hedge Funds, etc. become the preferred choices of investors. However, smart investors first evaluate the performance of the AIF and then invest.

The performance of AIFs is determined by their category and sub-category performance at a certain time. You can evaluate these performances by following a simple process.

Let’s understand how to evaluate the performance of alternative investment funds:

Step-by-Step Process for Evaluating AIF Performance

7-step process for evaluation of AIF performance:

Step 1: Systematic Risks

To evaluate how well an AIF is doing, you need to know how much risk the AIF is taking. Before analyzing the performance of AIFs, you have to look into the potential risks of AIFs, such as low transparency, complex strategies, low portfolio liquidity, diversification issues, etc.

Step 2: The Creation of a Benchmark

After understanding the systematic risks of AIFs, we can now move forward to creating a benchmark. Setting up an accurate benchmark for AIF is essential to obtaining a proper performance analysis.

Performance measurement benchmark varies as per the changes in systematic risks. Also, broader market indices create challenges for benchmarking.

Step 3: Peer Group Benchmarking

Calculating the fund performance of a group of funds can be easier with peer group benchmarking. We can compare the performance of the group’s funds with similar investment mandates and strategies.

However, performance metrics may differ as per the category and sub-category of the AIF designated by SEBI. However, we can use peer group comparisons to obtain a complete analysis of AIF performance.

Step 4: Performance Metrics

Performance metrics for AIFs vary by the category of AIF. For instance, category I and II AIFs are close-end investments with cash flows (drawdown and distributions), and they are controlled and divided by fund managers based on their availability of entry and exit opportunities.

Therefore, an appropriate measurement of performance can be done on the money-weighted value rate of return (MWRR) by using the pooled internal rate of return (IRR).

Pooled IRR is calculated at the combined level by pooling the cash flow from all the AIF schemes specific to the category of AIF and the vintage year. Here, the performance comparison of all AIFs is done for the same period, so the peer groups of funds with a similar starting year or vintage year are compared.

Once we have the internal rate of return, we can go further by measuring cash flows at the peer group level to compare investment and cash flow distribution models.

Step 5: Evaluation Metrics

Here are some key metrics to evaluate the AIF performance:

1. Distribution to paid-in (DPI) capital is a key metric to evaluate money returned versus money managed proportionally. DPI is the amount of paid-in capital that is distributed to investors.
2. Residual value to paid-in (RVPI) capital measures unrealized gains. RVPI is the ratio of the after-tax value of all investments remaining in the AIF after deductions to paid-in capital.
3. Total value paid-in (TVPI) evaluates the realized and unrealized gains for similar AIFs. TVPI is the portion of the balance of total distributions and residual value to the total paid-in capital.

Here, you can also use public market methods to understand the gains from an AIF based on various market indexes. These methods bring the AIF’s cash flows into the public index and help assess how the AIF’s investment will perform in the public market index.

Step 6: Selecting the Right Peer Group

To apply evaluation metrics, you have to select the correct peer group of AIFs. As an investor, you should prefer to evaluate benchmarks that categorize AIFs with actual portfolio allocation. You have to consider the category and sub-category of AIFs that are outperforming in the given vintage year.

Step 7: Qualitative Evaluation

The final step in evaluating the AIF’s performance is the qualitative evaluation. This part covers investment management, the decision-making processes, and supervision for AIFs which are equally important.

Through the analysis, you get a complete evaluation of AIF performance in a particular vintage year and compare it with other AIFs.

Conclusion

If this process interests you, or you want to know more about alternative investment funds, or you are looking for funds to invest, then contact us. We are managing two high-returning alternative investment funds by leading our investors to high gains.

StepTrade.Capital is here to strengthen your portfolio, earn you profitable returns, and align your investment goals with the better future.

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