Market valuations are above historical averages, so where should investors put their money? Whitespace Alpha’s Puneet Sharma explains

Alternative investment funds (AIFs) are gaining popularity in the country with the rise in the number of ultra-high net worth individuals (UHNIs). Data available with market regulator Sebi shows that total investments in AIFs stood at Rs 4.32 lakh crore in the June quarter, up 39% year-on-year. Of this, investments in Category III AIFs, which require a minimum investment of Rs 1 crore, saw a 73% year-on-year growth, and assets under management (AUM) stood at Rs 1.13 lakh crore in the first quarter of FY24. With benchmark indices like Sensex and Nifty hitting record highs, how can HNIs grow their wealth and manage risks? In an interview with Business todayPuneet Sharma, CEO and Fund Manager, Whitespace Alpha, Category III AIF, shares his thoughts on AIF, current market trends, risk management, promising sectors and more. Edited excerpts:

Q) Can you explain what Category III AIF is and how it differs from other categories?

Puneet Sharma: Category III AIFs are a specialized type of fund in India that focuses on high-risk, market-driven strategies such as long-short equity positions, derivatives, leverage, and arbitrage. These funds are different from Category I and Category II AIFs, which typically focus on long-term, low-risk investments such as infrastructure, social ventures, or private equity.

The key difference lies in their investment approach. Category III AIFs are designed to generate short-term capital gains through active trading of publicly traded securities. They can also use leverage, meaning they can borrow money to increase their gains, which inherently increases risk. Category I AIFs, on the other hand, are geared towards socially beneficial projects such as startups or infrastructure, while Category II AIFs focus on private equity and debt, neither of which can use leverage in the same way.

Q) What types of investors typically invest in Category III alternative investment funds?

Puneet Sharma:Investors in Category III AIFs are typically HNIs, family offices and institutional investors who have a higher risk tolerance and are looking for potentially higher returns. These investors are sophisticated, can understand the complexities and risks associated with high leverage strategies and are open to the possibility of market volatility.

Q) Markets are seeing record gains. How do you see this trend continuing?

Puneet Sharma: Indian markets are currently trading at a P/E ratio of 27.25, which is well above the historical average of 22-23. This elevated valuation signals one of two potential outcomes: either we see a significant increase in corporate earnings to justify these high levels, or the market may undergo a necessary correction for valuations to return to normal.

Given these circumstances, it makes sense to focus on large-cap companies with strong fundamentals and resilient business models. These companies, with their solid balance sheets and proven track records, are more likely to weather market volatility. Moreover, in such overvalued environments, passive investment strategies that track large-cap indices offer an effective way to capture market gains while mitigating the risks inherent in active management.

In a valuation-tight market, passive strategies that emphasize quality, stability and cost efficiency become even more attractive, especially when they avoid the challenges of timing corrections in an overheated market.

Q) What investment strategies does your fund use and how do they fit into current market trends?

Puneet Sharma: Whitespace Alpha follows a passive investment strategy, focusing on supplementing returns with low-risk derivative strategies. This approach allows the fund to deliver consistent performance with minimal market exposure. Given the current market environment of high valuations, this strategy is particularly relevant as it mitigates the challenge of delivering alpha through traditional active management.

By using derivatives such as options and futures, the fund minimises risk while also capturing growth potential without having to make significant directional bets. This is in line with current trends where passive investing is gaining popularity, particularly in India, as investors seek cost-effective and risk-averse ways to deal with market volatility.

The fund’s derivatives focus further complements its strategy by providing a buffer against downside while maintaining stable, incremental returns. Given the increasing difficulty for active managers to outperform their benchmarks in a highly valued market, this strategy positions Whitespace Alpha to consistently outperform by maintaining a conservative yet opportunistic approach.

Q) How do you manage risk in the fund?

Puneet Sharma: Our proprietary risk models constantly monitor market conditions, helping us proactively manage risk by identifying potential threats or opportunities in real time. We enforce strict position sizing to avoid overexposure to individual stocks or sectors. This helps reduce concentration risk and ensures a balanced, diversified portfolio.

We have a robust ongoing Value at Risk (VaR) monitoring system that helps us quantify potential losses over a specified period under normal market conditions. By monitoring VaR, we can ensure that risk levels remain within acceptable limits, preventing unexpected shocks to the portfolio. We use derivatives such as options and futures to hedge our positions, which helps limit downside risk. This approach gives us the flexibility to dynamically adjust exposure without taking on excessive risk.

Q) What key sectors or industries is your fund currently focused on and why?

Puneet Sharma: At Whitespace Alpha, our strategy is deliberately sector agnostic and focused on achieving consistent returns through market-neutral investing. We invest exclusively in benchmark indices and AAA-rated government bonds, avoiding concentrated bets on any particular sector. This approach allows us to capture the performance of the broader market without exposing ourselves to the volatility that often accompanies sector investing.

By holding blue chip stocks tied to benchmark indices, we align our portfolio with the general market, while AAA-rated government bonds provide a level of stability and risk mitigation. These bonds provide reliable income streams and protect the fund during periods of market turbulence.

Our investment philosophy is to remain long-term focused on growth while effectively managing risk through market-neutral strategies. This allows us to navigate swings and corrections with minimal volatility, ensuring that our investors benefit from a stable, well-balanced portfolio without sector-specific risks.

Q) What liquidity options do your investors have and how important is liquidity management in your fund?

Puneet Sharma: In the Equity plus fund, we offer a 36-month lock-in period for most investors, but those investing more than ₹1.25 crore do not have a lock-in period, giving them the freedom to move their capital easily. The Debt plus fund offers monthly liquidity, making it ideal for investors who value instant access to their funds. In the Hybrid plus fund, liquidity is managed through a graduated exit load—2% in the first year, 1% over 12-24 months and no exit charge after 24 months.

What really sets us apart is our focus on liquidity management. We have developed proprietary systems to ensure that we can liquidate positions when needed, even in stressed markets. This is essential to preserving value and maintaining the stability of our portfolios. By investing in high quality, liquid assets, we ensure that investor redemptions are met without disrupting market prices or the fund’s overall strategy.

For us, liquidity management is not just a process – it’s about providing peace of mind to our investors, making sure they have access to capital when they need it, while maintaining the integrity and performance of the fund.

Q) How has the fund performed over the last few years and how do you intend to maintain or improve this performance?

Puneet Sharma: The fund has consistently outperformed the market benchmarks over the last few years, averaging 10-12% alpha per annum. For instance, in FY23, we outperformed Nifty 50 by around 11.6%, which demonstrates our ability to generate higher returns even in challenging market conditions.

Looking ahead, we plan to stick with this strategy – waiting out any potential corrections, as the market will likely return to delivering 12-15% annual returns once the current phase of high valuations stabilizes. We remain focused on long-term, stable returns, ensuring the fund continues to outperform while maintaining a low risk profile.

Innovation plays a key role in our approach. By continually refining our proprietary models and staying at the forefront of data-driven strategies, we remain agile, accurately capturing market inefficiencies. This combination of innovation and discipline allows us to consistently outperform, even in changing market conditions.

Q) What kind of return can be expected from a Category 3 AIF over the long term (e.g. 5 years)?

Puneet Sharma: Over the longer term, typically over a 5-year period, investors in Category 3 AIFs can expect annual returns in the range of 12% to 16%, depending on the fund’s specific strategy and risk profile. Category 3 AIFs often employ complex strategies such as leverage, derivatives and long-short positions, which can generate alpha beyond traditional benchmarks such as the Nifty 50.

However, the exact returns depend significantly on the type of Category 3 AIF. Some funds may pursue higher risk, higher reward strategies, potentially delivering returns at the higher end of the range, while others focus on more conservative approaches that still outperform benchmarks but with lower volatility. The combination of active management and sophisticated strategies typically allows these funds to generate better risk-adjusted returns over time, but market conditions, leverage and the fund’s specific focus play key roles in shaping actual returns.