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Are post-fee and post-tax returns of long-short strategies still attractive?

IME Capital Investment Queries provide answers to common investor queries that are directly written by IME Capital’s Central Investment Team. This helps ensure centralised, common and transparent communication of our thoughts to all investors (& potential investors) of IME Capital, and helps mitigate against the disparate communication common in the wealth management industry.

Written by IME Capital’s Investor Desk on May 26, 2022

Long-short AIF’s that aim to deliver positive absolute returns that are uncorrelated to market conditions, are a popular and fast growing segment in the Indian alternatives industry. However, due to the use of derivatives, the taxation of these funds are unfavourable since gains are typically considered speculative income (tax rate of 35% in case of an LLP and 42.7% in case of a trust). Are the returns of such strategies still attractive post accounting for fees and taxes?

The answer depends on the specific fund in question and the investors objective. Many marketing presentations depict gross returns of the strategy, and actual returns in the hands of the investor are lower after accounting for fees & taxes. The relatively weak flow down of gross to net returns is clear disadvantage of such funds.

However, it is important to understand the substantial risk-reduction and diversification benefits that these funds provide from a portfolio construction perspective. Additionally typically, while the post-tax returns may be lower than equity funds, they tend to be substantially higher than debt funds.

Accordingly, we clearly see merit of long-short strategies in an investors portfolio (subject to their investment mandate), given their risk-reduction & diversification benefits.

We provide below a quick example of how gross returns translate to net returns in a long-short strategy (please note, the actual flow down depends on the specific funds gross returns, fee & corporate structures).