Why regulators are going tough on AIF industry?

What are AIFs?

Alternative investment funds (AIFs) are investment plans that allocate funds to securities other than stocks and bonds. It is primarily made up of private equity and venture capital.

Background:

AIF valuations were previously unregulated. Since the investment industry is now bullish on investing in the private equity sector, the government is imposing stringent guidelines on securities valuation techniques.

Standard approaches for valuation:

• SEBI and other regulators have recommended international standards for AIF valuation.
• SEBI advises using discounted cash flow methods to value such instruments, considering market prices for comparable securities.
• The investor must disclose its valuation methods. If the investment company's valuation method changes, disclosure is required.
• The valuation is required to be done by independent assessors. Independent assessors must be a non-AIF manager, sponsor, or trustee with three years of unlisted securities valuation experience.
• Unlisted securities can assist small-category AIFs in valuing their assets. The manager must inform investors of the reason for a 33% valuation variance in a fiscal year.

Discounted Cash Flow (DCF) Valuation:

A discounted cash flow (DCF) valuation is a financial model that uses future cash flows to determine the worthiness of an investment. A DCF model is based on the premise that the value of a company is defined by its ability to generate future cash flows for its owners.

Net Asset Value (NAV) or Asset-based approach:

Net assets are calculated by subtracting liabilities from assets. The market value of a company's assets and liabilities is frequently adjusted to calculate its net asset value.

The Purpose:

A consistent valuation methodology for an investment portfolio ensures that its value is accurately disclosed to investors. It will also ensure that valuation methodologies are consistent throughout the AIF industry and that AIF performance is fairly benchmarked using consistent valuation methods.