Investors from other countries are pouring substantial funds into India, but not only restricted to the stock exchange.
Foreign institutional investors (FIIs) are increasingly allocating substantial capital to illiquid private markets in emerging economies, such as India, in a bid to secure higher returns than public markets can offer. This strategy, while fraught with increased risks and limited liquidity, is driven by the structural growth opportunities and the risk-reward profile of private market investments.
### The Logic Behind the Investment Strategy
The higher expected returns for investing in illiquid private markets stem from the increased risks associated with illiquidity, regulatory, political, and corporate governance issues. Historical data shows that liquid public equities in India have delivered around 15% returns over the long term. However, investors demand significantly higher returns when investing in private markets due to the increased risks. This higher "hurdle rate" of return justifies the substantial allocation to illiquid assets.
India's growth and infrastructure needs present large-scale investment opportunities across various sectors, including business scaling, physical infrastructure, commercial, and residential real estate. Foreign investors view private markets as essential to generating outsized growth by directly supporting these sectors.
Moreover, the scarcity of high-quality, well-structured private market investment products accessible to global and domestic investors further drives demand and allocations towards these illiquid assets. Investment platforms are evolving to meet this demand, offering diversified private equity, real estate, infrastructure, and soon private credit opportunities.
### The Impact on Returns and Risks
The illiquid nature of private market investments limits exit options and timing, exposing investors to lock-up periods and possible valuation challenges. While these investments may offer potentially higher returns than public markets, they also come with elevated risks such as regulatory and political uncertainties, weaker governance standards, and longer investment horizons.
The limited liquidity of private market investments means that optional listing on exchanges, as for some Alternative Investment Funds, is rare and often thinly traded, maintaining limited liquidity. However, private market allocations can diversify portfolios beyond traditional listed assets, potentially reducing overall volatility if managed properly.
### Strategic Outlook
Foreign investors are effectively "rolling the dice," willing to accept increased governance, liquidity, and political risks in emerging markets' private sectors like India in pursuit of superior long-term returns. This reflects confidence in India’s growth trajectory and the belief that private markets offer unique opportunities unavailable in public markets.
In summary, the substantial allocation by foreign institutional investors to illiquid private markets in India is driven by the pursuit of higher risk-adjusted returns and the unique investment opportunities offered by India’s rapidly expanding economy. Investors adopting this strategy must balance the potential for outsized gains against the inherent uncertainties and illiquidity of private market investments.
[1] Data from various IVCA reports on trends in private equity and venture capital industry. [2] NSDL FPI Monitor, IVCA Trend reports, RBI. Data annual calendar year for 2003-2024. [3] The views and opinions expressed in the article are Arvind Chari's personal views. Arvind Chari is the Chief Investment Strategist at Q India UK, Ltd, an affiliate of Quantum Advisors Pvt Ltd, guiding global investors on their India allocation and having over 20 years of experience in long-term India investing across asset classes. [4] The article is for educative purposes only and is NOT a recommendation. If considering an investment, it is strongly advised to consult an advisor.
- The higher returns for investing in illiquid private markets in India are due to the increased risks associated with illiquidity, regulatory, political, and corporate governance issues.
- Private market investments in India offer significant investment opportunities across various sectors, including business scaling, physical infrastructure, commercial, and residential real estate.
- Investment platforms are evolving to meet the demand for diversified private equity, real estate, infrastructure, and soon private credit opportunities.
- The illiquid nature of private market investments in India limits exit options and timing, exposing investors to lock-up periods and possible valuation challenges, but they can diversify portfolios beyond traditional listed assets.
- Foreign investors view private markets as essential to generating outsized growth by directly supporting these sectors in India, as they are willing to accept increased governance, liquidity, and political risks to secure superior long-term returns.
