How AIFs help reduce exposure to market volatility
AIFs provide investors with access to alternative asset classes such as hedge funds, private equity, real estate investment trusts (REITs), and venture capital. These alternative investments are typically less correlated with traditional markets, making AIFs an effective tool for reducing volatility exposure. By employing strategies such as market neutrality, dynamic adjustments, and better risk management, AIFs help create more stable portfolios.
According to Niresh Maheshwari, Director of Wealth Wisdom India Pvt. Ltd., “By using strategies such as market neutrality and better risk management, AIFs are designed to navigate volatile market conditions while delivering higher risk-adjusted returns.” These approaches are specifically intended to buffer investors against sharp market movements, providing a more predictable performance.
AIFs and their low correlation with traditional markets
One of the main advantages of AIFs is their low correlation with traditional financial markets. While stock markets often move in tandem, AIFs invest in assets such as real estate, infrastructure, and niche businesses that are less influenced by market fluctuations. This diversification enables AIFs to perform well even when traditional markets experience downturns.
During economic crises, AIFs offer resilience by focusing on high-risk assets that can generate significant returns. Additionally, these funds often benefit from government incentives and tax relief, which further enhances their stability and appeal during volatile periods.
Performance of different AIF types in volatile markets
Different types of AIFs respond to market volatility in various ways. Category 1 AIFs, which typically invest in long-term assets like infrastructure and start-ups, are less sensitive to short-term market movements. These funds prioritise long-term growth, helping investors ride out market cycles.
Category 2 AIFs, which focus on private equity and debt investments in unlisted businesses, provide stability by supporting firms with lower exposure to market fluctuations. Meanwhile, Category 3 AIFs, such as hedge funds, implement strategies like arbitrage and derivatives trading to profit from market shifts, though they remain exposed to market changes.
Real estate funds, backed by tangible assets, also perform well in volatile markets due to their inherent value. These funds are less dependent on stock market performance, helping reduce direct exposure to equity market risks and offering more stable returns.
Resilience of AIFs during past market crashes
Historical performance further underscores the resilience of AIFs. During the 2008 financial crisis and the market crash in 2020, AIFs outperformed traditional investments. While the stock market suffered significant losses, AIFs remained relatively stable by employing strategies like asset rotation. “When markets fall sharply, AIFs use a rotation strategy—returns from higher-performing assets are reinvested into asset classes with lower valuations,” says Maheshwari. This helps optimise returns and stabilises the portfolio.
