NISM-Series-XIX-A: Alternative Investment Funds (Category I and II) Distributors Certification Workbook

Chapter 8: Fund Due Diligence – Investor Perspective (Part 4 of 5)

Fund Benchmarking & Sales Strategy Formulation by Distributors

In the Alternative Investment Fund (AIF) sector, transparency and standardized performance comparison have historically been significant challenges. Because AIFs are privately pooled and invest in unlisted, illiquid securities, investors cannot easily evaluate a manager's performance against public indices. To address this, the Securities and Exchange Board of India (SEBI) introduced a mandatory framework for performance benchmarking.

This study guide—Part 4 of our 5-part series—covers Section 8.6 (Fund Benchmarking) and Section 8.7 (Sales Strategy Formulation by Distributor). It details SEBI’s operational guidelines for performance benchmarking, the distinction between standard and customized reports, and how distributors design compliant, highly targeted product pitches using case studies from the NISM curriculum.

1. Fund Benchmarking (Section 8.6)

Performance benchmarking is the practice of comparing a fund's returns and operational metrics against an industry-wide peer group or market surrogate. In the AIF ecosystem, benchmarking provides investors with an objective tool to measure "alpha"—the excess return generated by the manager's active strategies over the market average.

The Appointed Benchmarking Agencies

To ensure independence and professional rigor, the Indian Private Equity and Venture Capital Association (IVCA) has appointed specialized benchmarking agencies to compile data and publish official AIF benchmarks. Currently, these services are provided by three registered agencies:

• CRISIL
• NSE (National Stock Exchange)
• Preqin

These agencies report performance data and industry benchmarks in both INR (Indian Rupee) and USD (United States Dollar) terms to cater to domestic and international investors alike.

The Regulatory Exclusion

• Angel Funds: The mandatory performance benchmarking framework does not apply to Angel Funds registered as a sub-category of Venture Capital Funds under Category I AIF. Angel investments occur at an exceptionally early stage in a business's life cycle and rely on highly individualized terms, making standardized peer comparisons impractical.

2. SEBI's Operational Guidelines for Performance Benchmarking

SEBI has established highly structured operational guidelines for implementing AIF benchmarking, divided into two distinct sections:

Section A: Standard Performance Benchmarking (The Mandated Framework)

The rules governing standard performance reporting are designed to ensure consistency, accuracy, and fairness across all registered AIF schemes:

1. Reporting Frequency: Benchmarking is conducted on a half-yearly basis, using performance data as of September 30 and March 31 of each year.
2. Audit Requirements: The performance and valuation data submitted for the March 31 reporting cycle must be fully audited. For the September 30 cycle, managers are permitted to submit unaudited data.
3. The One-Year Threshold: All AIF schemes that have completed at least one year from the date of their First Close are contractually and regulatorily obligated to provide their investment data to the designated benchmarking agencies.
4. Required Data Points: Schemes must share detailed data regarding their historical cash flows (capital calls and distributions) and the valuation of their scheme-wise investments. This reporting format must explicitly state the valuation principles used and the name of the independent Valuation Agency appointed by the AIF.
5. Assets under Management (AUM) Definition: For the specific purpose of AIF reporting and performance benchmarking, AUM is defined as the value of the total capital drawn down under the scheme, rather than the total committed corpus.
6. Pre-Tax Reporting: Benchmarking agencies must calculate all performance metrics based on the pre-tax Net Asset Value (NAV) of the AIF scheme.
7. Vintage-Year Groupings: To ensure a fair comparison, Category I and Category II AIFs are benchmarked based on their vintage years. Vintage-year peer groups bundle together schemes with similar first close timelines. This prevents a mature, fully harvested fund from being compared directly with a newly launched fund that is still experiencing the negative cash flows of the J-Curve investment phase.
8. Comparative Benchmarking Metrics: The standard reports utilize globally recognized private capital metrics:
   • Pooled Internal Rate of Return (Pooled IRR)
   • DPI Multiple (Distribution to Paid-In Capital)
   • RVPI Multiple (Residual Value to Paid-In Capital)
   • TVPI Multiple (Total Value to Paid-In Capital)
9. Additional/Customized Industry Benchmarks: Recognizing that different funds within the same SEBI category can pursue wildly different strategies, benchmarking agencies are permitted to create additional performance benchmarks. These must be based on objectively verifiable parameters, such as the focus sector, investment instrument, or specific fund tenure/vintage.
10. The Benchmark Report: Upon compiling the industry data, the agency generates a standardized Performance Benchmark Report comparing each individual AIF scheme directly against its peer group.

Section B: Customized Performance Reports (The On-Demand Service)

While the standardized Benchmark Report is a regulatory mandate, AIFs often require tailored reports to showcase specific competitive advantages to prospective LPs. Section B of SEBI's guidelines outlines the rules for these bespoke documents, which are formally designated as "Performance Reports" (as opposed to standard Benchmark Reports):

• The Consent Rule: A benchmarking agency can only include an AIF's data in a customized performance report if it obtains the express written consent of all the AIFs whose data is required for the analysis.
• Identification & Attestation: The subset of AIFs chosen for the custom comparison must be identified either through self-attestation by the participating AIFs or via independent verification conducted by the benchmarking agency.
• Commercial Nature: Unlike the mandated standard reports, the preparation of a customized Performance Report is a fee-based commercial service. The pricing is mutually decided between the requesting AIF AMC and the benchmarking agency.

3. Sales Strategy Formulation by Distributors (Section 8.7)

An AIF distributor's primary commercial objective is to formulate an ethical, compliant, and highly effective sales strategy. This process relies heavily on translating the complex, technical disclosures contained within the fund's Private Placement Memorandum (PPM) into structured, easy-to-understand product literature.

Key Components of an Effective AIF Sales Pitch

A distributor's customized sales pitch must align the fund's features with the specific profile of the targeted investor:

1. Target Risk-Return Alignment: Demonstrating how the fund's target IRR and underlying volatility match the investor's risk appetite.
2. Time Horizon Match: Ensuring the close-ended tenure of the AIF aligns with the client's liquidity timeline.
3. Comparative Alternatives: Providing a clear, objective comparison between the proposed AIF scheme and other available AIF or non-AIF investment vehicles.
4. Portfolio Capital Commitment Fit: Helping the investor map out how the fund's ad-hoc drawdown schedule fits into their overall portfolio allocation and liquid treasury reserves.
5. Investment Team Compatibility: Highlighting the track record, stability, and operational credentials of the fund's investment management team.

4. Practical Application: Case Studies in Product Mapping

To master product mapping, distributors must study real-world scenarios where investor objectives are matched against distinct AIF strategies. The NISM workbook highlights two primary case studies:

Case Study 8.1: The Star Pension Fund Asset Mapping

The Investor Profile

• Entity: Star Pension Fund
• Risk Appetite: Medium risk-oriented, focus on steady, long-term exposures
• Time Horizon: 6 to 7 years investment tenure
• Liquidity Expectations: Requires interim payout possibilities starting after Year 3
• Commercial Constraints: Hurdle rate expectation of 7% to 8% p.a.; management fees capped around 1.5% p.a.; additional performance carry limited to a modest 10% to 15% range.

The Product Alternatives

• Option A (High-Technology Equity AIF): Focuses on investing in early-stage, new-age digital start-ups (SaaS, FinTech, Artificial Intelligence, and Data Analytics).
• Option B (Real Estate Equity AIF): Primary strategy involves co-investing with developers in raw land bank acquisitions and constructing large logistics and warehousing parks.
• Option C (Alternative Debt Fund): Invests in unlisted, long-term secured bonds and debentures issued by real estate Special Purpose Vehicles (SPVs). These SPVs hold active, revenue-generating operational leases (such as co-working office spaces and co-living housing projects). The fund also finances select projects under construction that will commence active leases within the next 2 to 3 years.

The Best-Fit Determination & Rationale

• Selected Best-Fit: Option C (Alternative Debt Fund).
• The Commercial Rationale: Star Pension Fund's fundamental objective is capital preservation coupled with a steady, reliable stream of interim cash distributions.
  • Option A (Early-Stage Tech VC) is completely incompatible due to high mortality rates, extreme valuation volatility, and a complete lack of interim distributions (yield).
  • Option B (Real Estate Land Acquisition) carries severe development risks, regulatory approval delays, and illiquid construction cycles, which do not guarantee cash distributions by Year 3.
  • Option C utilizes unlisted, secured debt instruments backed by active operational leases, providing the stable, predictable cash flows required to fund Star Pension's interim distribution requirements after Year 3. Note: The specific management fee terms must still be negotiated to fit the 1.5% cap.

Case Study 8.2: ABC Alternates – Off-Shore ESG Capital Sourcing

The Fund Manager Profile

• AMC: ABC Alternates Pvt. Ltd.
• Investment Thesis: Clean energy, self-sustainable green buildings, waste recycling, soil rejuvenation, and environmental sustainability ventures.
• Target Instruments: Dual exposure through a combination of early-stage private equity and green bonds.
• Capital Sourcing Objective: Targeting overseas institutional capital to achieve a successful fund close.

The Prospective Investor Alternatives

• Option B: Domestic Institutional Investors in India looking to deploy capital into AIFs focused on social impact, sustainable communities, and general ESG ventures.
• Option C: An Institutional Investor Consortium based in Europe seeking direct investment in AIFs that target clean energy assets and environmental technologies with a long-term view on capital growth and sustainable wealth creation.
• Option D: A large Middle-Eastern Sovereign Wealth Fund (SWF) looking to acquire strategic energy assets, hydrocarbon gas fields, and remote offshore deep-sea exploration projects.

The Best-Fit Determination & Rationale

• Selected Best-Fit: Option C (European Institutional Consortium).
• The Strategic Rationale: ABC Alternates' investment strategy is highly specialized, targeting clean technology development and ecological assets.
  • Option D (Middle-Eastern SWF) is a direct strategic mismatch, as its focus remains on traditional fossil fuels and hydrocarbon extraction.
  • Option B (Domestic ESG Investors) is a partial match, but domestic mandates are often geared toward broad social ventures rather than specialized environmental technologies.
  • Option C is the optimal match because the European consortium's explicit mandate—investing directly in clean energy technologies with a long-term capital appreciation view—aligns perfectly with ABC's portfolio construction targets.

5. Important Terms and Glossary

• AUM (Assets under Management): In the context of SEBI’s benchmarking guidelines, AUM represents the cumulative value of capital drawn down from investors, rather than the total committed capital.
• Benchmark Report: The standard, regulatorily mandated report published by benchmarking agencies comparing an AIF scheme's pre-tax NAV returns against its vintage-year peer group.
• Performance Report: A customized, fee-based report generated by benchmarking agencies under Section B guidelines, requiring the express consent of all participating AIFs.
• Vintage Year: The specific calendar year in which an AIF scheme declares its First Close, used to group peer funds for fair performance comparisons.
• DPI Multiple: Distribution to Paid-In Capital; a ratio measuring the total cash returned to investors relative to the total capital they have paid into the fund.
• TVPI Multiple: Total Value to Paid-In Capital; calculated as the sum of DPI and RVPI, representing the total paper and cash value generated by the fund relative to paid-in capital.

6. Key Exam Takeaways

• Benchmarking Exclusions: Angel Funds are completely exempt from the mandatory SEBI benchmarking guidelines.
• AUM Benchmarking Definition: Unlike standard corporate metrics, the AUM used for benchmarking comparisons is strictly defined as the total capital drawn down.
• Pre-Tax Basis: All performance metrics analyzed by CRISIL, NSE, or Preqin must be calculated using the fund's pre-tax NAV.
• Benchmark Report vs. Performance Report: Standard, SEBI-mandated comparisons are called Benchmark Reports, whereas customized, commercial comparisons are legally designated as Performance Reports.
• The Consent Rule: Benchmarking agencies are strictly prohibited from utilizing an AIF's private data to generate customized Performance Reports without obtaining express written consent from the respective schemes.

7. Practice Questions

Question 1

Under the operational guidelines specified by SEBI for AIF performance benchmarking, "Assets under Management" (AUM) is defined as:

a) The total capital committed by investors as of the final close
b) The value of the total capital drawn down under the scheme
c) The net asset value of the fund plus outstanding debt liabilities
d) The total market value of all listed securities in the portfolio

Question 2

Which of the following sub-categories of Alternative Investment Funds is explicitly exempt from SEBI's mandatory performance benchmarking regulations?

a) Special Situation Funds
b) Infrastructure Debt Funds
c) SME Funds
d) Angel Funds

Question 3

An AIF manager requests CRISIL to create a customized comparative report comparing their fund against five specific peer funds. Under SEBI's Section B guidelines, this custom document:

a) Is called a "Benchmark Report" and can use peer data without consent
b) Is called a "Performance Report" and requires the express consent of all participating peer funds
c) Is a free regulatory service funded by SEBI
d) Can only be generated using audited data from the September 30 cycle

Question 4

In AIF benchmarking, why are Category I and II AIF performance metrics primarily compared based on "vintage years"?

a) To ensure funds with different tax pass-through status are grouped together
b) To compare funds that have similar focus sectors, regardless of launch dates
c) To bring uniformity by comparing funds with similar first close timelines, accounting for J-Curve differences
d) To benchmark unlisted debt funds against public market equity indices

Answer Key & Explanations

1. Correct Answer: b)
   Explanation: SEBI’s benchmarking guidelines explicitly state that Assets under Management (AUM) for the purpose of reporting and benchmarking shall be the value of the total capital drawn down under the scheme.

2. Correct Answer: d)
   Explanation: The benchmarking guidelines do not apply to Angel Funds registered under the sub-category of Venture Capital Fund under Category I AIF.

3. Correct Answer: b)
   Explanation: Under Section B of the operational guidelines, customized reports are designated as "Performance Reports" (as opposed to standard "Benchmark Reports") and require the express written consent of all AIFs whose data is used.

4. Correct Answer: c)
   Explanation: Comparing AIFs based on vintage years ensures that funds at similar stages of their investment and harvesting cycles are compared, preventing unfair comparisons between new funds in the J-Curve drawdown phase and mature funds in the exit phase.