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Hedge funds for retail investors on the way

The most popular type of hedge funds abroad, long-short funds, will soon be within the reach of retail investors in India. With Sebi indicating that mutual funds will be allowed to sell stocks without actually owning them (called short selling), many fund houses are in final stages of designing products that will allow small investors to have a taste of this sophisticated style of investing.

In fact, ICICI Prudential has become the first fund house in the country to consider launching such a product and is seeking Sebi’s permission to introduce a long-short fund. This is a technical name for a fund that allows a fund manager (and thus investor in the fund) to hold those stocks that he is bullish on and yet sell those, whose prices he feels will fall in the future.

In November last year, capital market regulator Sebi had asked mutual funds to engage in short-selling of securities as well as lending and borrowing of securities. Earlier, no institutions (foreign institutional investors (FIIs), insurance players or mutual funds) were allowed to do this.

The change in regulation has not only opened up another avenue of revenue (lend securities and earn), but allowed fund houses to launch such innovative long-short funds.

For any market participant looking to short sell shares in the market, he will have to borrow the same amount of shares from somebody who already has them, and has to pay the lender previously fixed rates (akin to rental charges).

Globally, long-short funds are the most common types of hedge funds. This type of funds are popular as they allow wider scope for profit-making than traditional stock-picking which limits itself to earning a return only from stocks which go up.

For instance, the draft prospectus submitted by ICICI Prudential to Sebi mentions two ways about how it will generate extra returns — one is by taking equity exposure up to 130% (long position) of the portfolio value in index or companies that are expected to have high returns, and/ or give relative out-performance.

Second, by selling (take short positions) up to 30% of the portfolio value by selling index or stocks, which are likely to fall in price and/ or give relative under-performance.

As a result, the net equity exposure of the fund will be 130% long — 30% short, the document explains.

The best part, however, is that investing in such funds (several fund houses are looking to come out with such products once Sebi clarifies further on regulations) will incur only average costs, just like any other existing fund scheme.

But investors should keep in mind that the product by nature is a high risk taking one, so it should only be used as enhancing the returns of a portfolio. And not a core part of it.
Source: Economic Times

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