Specialised Investment Funds: How to evaluate strategy, risk, derivatives and red flags before investing in SIFs

An investor today largely knows the ins and outs of investing in a mutual fund. Pick a category, scan the three- and five-year returns, see who runs the fund, check the expense ratio, study the portfolio, and understand the risk-o-meter. That playbook no longer works for specialised investment funds (SIFs).

Two equity long-short SIFs can be launched on the very same day, sit in the very same category, and still behave almost the opposite way. One manager may use derivatives purely to hedge and cushion falls. Another may actively short stocks to chase extra returns. So how to evaluate an SIF?

Strategy over category

Traditional mutual funds are categorydriven; SIFs are strategy-driven. As Amol Patel, Lead Product Specialist, ICICI Prudential Asset Management Company, puts it, “Understanding the investment strategy is critical because, in an SIF, the strategy, and not the scheme name, is the primary driver of returns and risks.”


Highlighting the contrast further, Niharika Tripathi, Head–Products and Research, Wealthy.in, says, “SIFs should not be understood as regular mutual funds with only a higher minimum investment. The larger difference lies in the strategy, flexibility and riskreturn profile.”

Nitin Agrawal, CEO–Mutual Funds, InCred Money, describes the design intent: “SIFs occupy a carefully designed middle ground in the Indian investment landscape, more flexible than mutual funds, more accessible than PMS.”

They were created for investors who have outgrown the standardised constraints of mutual fund categories but do not meet the `50 lakh minimum that portfolio management service (PMS) demands. The SIF entry threshold sits at Rs.10 lakh per investor. Mutual funds, Agrawal adds, operate within tight category mandates, while SIFs can employ long-short strategies, use derivatives more actively, and construct portfolios that would not fit neatly into any existing mutual fund category. According to Tripathi, an SIF is “better viewed as a satellite allocation that complements the mutual fund core portfolio rather than as a replacement for traditional equity and debt investments.”

RADHIKA GUPTA MD and CEO,
Edelweiss Mutual Fund
Note:“The differentiator between two or three SIFs, if you compare, is how they are using the derivative strategies.”

The reading checklist

Here’s how to read SIF documents.
The objective: Start with the investment objective, and read it critically. As Agrawal says, it “tells you what the fund is trying to achieve, over what horizon, and within what risk parameters.” Tripathi adds that “the first thing to grasp is what the SIF is trying to do within the portfolio, whether that is to reduce downside risk, improve risk-adjusted returns or provide differentiated exposure.”

But do not take the objective at face value. Patel says, “While the objective may use broad phrases such as capital appreciation or risk-adjusted returns, the strategy explains how the fund intends to achieve those outcomes, whether through dynamic asset allocation, derivatives, short positions or concentrated sector exposures.”

The strategy: Agrawal is clear: “If you cannot explain the strategy in two or three sentences to yourself, you should not be putting money into it.” Tripathi notes that the SIF universe spans seven differentiated strategy categories across equity, debt and hybrid— from ‘equity long-short’ and ‘sector rotation long-short’ to ‘debt long-short’ and ‘active asset allocator long-short’. So, “the broad SIF label does not tell investors exactly how a particular fund will generate returns or what risks it will take.”

Even within one category, she cautions, two funds may diverge: “One manager may use the short book primarily to protect the portfolio, while another may use it actively to generate additional return.”

Asset allocation: Here, investors make a common error: they look at where the money sits today. What matters more is where it is allowed to go. Patel says that asset-allocation pattern and investment limits show the permissible exposure to equity, debt, derivatives and short positions.

A portfolio that looks conservative now may be permitted to take on far more aggressive positioning tomorrow. The limits define the outer edge of the risk you are signing up for; the current exposure is merely one day’s snapshot. A fund may currently hold only 65-70% in equities, but its investment mandate allow it to increase equity exposure to 80-100% (or use derivatives extensively). This shows why the current portfolio looks conservative, while the actual risk can be much higher.

Derivatives: The critical question, as per Agrawal, is whether derivatives are being used “for hedging, for generating alpha, or for expressing leveraged directional views.” Tripathi warns that derivative use “should not automatically be treated as hedging”, a prudent hedge offsets a risk already in the portfolio, while an active position expresses “an independent view that a stock, sector or market will underperform.”

Ravi Kumar T. V., Director, Gaining

Ground Investment Services, stresses that an investor must first understand how instruments such as written call options work: “One has to understand, only then they will appreciate the risk-adjusted returns.”

A call option gives the buyer the right to buy a stock at a fixed price. When a fund sells (writes) a call option, it earns a premium but may have to sell the stock at the agreed price if it rises sharply, limiting gains. Investors should understand this risk before investing.

Risk factors: Agrawal notes that disclosures around leverage limits, counterparty risk, liquidity risk, and derivatives in stress scenarios tend to be written in the densest language precisely because they describe the fund’s most complex risk exposures.

Reading disclosures

There are several disclosures which are unique to SIFs. Radhika Gupta, Managing Director and CEO, Edelweiss Mutual Fund, begins with the risk band. Risk bands in SIFs are a standardised five-level risk-labelling system that helps investors understand the potential risk associated with different investment strategies, ranging from level 1 (lowest risk) to level 5 (highest risk).

In mutual funds, Gupta points out, the risko- meter is largely static within a category. “For example, when you are looking at a midcap fund, the risk-o-meter for all such funds will be high risk only. It doesn’t change.”

But SIFs are different. The risk band, she says, reflects the additional risk being assumed by the portfolio manager, particularly through the use of derivatives. “If derivatives are used to hedge, the risk band level will be lower. If it is to enhance return and it is taking naked shorts or open equity exposure, then the risk band will be on the higher side,” she explains. Comparing risk bands within the same category, hence, becomes essential.

The second disclosure Gupta highlights is the mandatory portfolio disclosure, which is published on the fund house’s website before the 10th of every month. “There, one can check whether a strategy uses naked open exposure shorts, hedges or arbitrage positions.” That is the crux. “The differentiator between two or three SIFs, if you compare, is how they are using the derivative strategies,” she adds.

For the technically minded, Agrawal lists disclosures that separate marketing from mechanics: gross exposure versus net exposure— the total of long and short positions against the portfolio’s actual directional bet; the size and purpose of the long portfolio and the derivative portfolio; and the extent of unhedged short positions.

Same, but different

So how does an investor actually choose between three equity long-short SIFs? Gupta lays out a sequence. Investors should start by understanding the positioning of the strategy: how much derivative exposure the fund intends to use, whether derivatives are being used primarily for hedging, and whether the fund is willing to take naked short positions. The next step is to assess the risk band: a conservatively positioned strategy would be expected to have a relatively lower risk band than one pursuing more aggressive derivative exposure. Investors should then evaluate whatever performance history is available, paying particular attention to volatility, drawdowns during difficult market periods and the overall portfolio composition.

Kumar makes the shorting mechanics concrete. In an equity long-short SIF, he explains, the fund manager can hedge “up to 25% of the net asset value,” so that when markets fall, the fund may fall less. But that protection is not automatic: “It all depends on the manager’s execution capabilities. His strategy can also go wrong. Or if he’s too late in executing the strategy, it can go wrong.”

He also reframes what SIFs promise: not higher returns, but “a higher probability of downside protection if markets remain volatile.” A long-short fund “can underperform in a very strong bull market, because you are trying to give up something to get low volatility.” It is not, he stresses, “a question of low risk, it is a question of lower risk.”

Benchmark or not?

Since SIFs use derivatives and short positions to alter their market exposure, can judging them against a traditional index like the Nifty 500 be misleading? Gupta believes a broad market index can still serve as a useful reference point, but investors should focus on risk-adjusted outcomes rather than just absolute returns. Given the flexibility available to long-short strategies through the use of derivatives, a more meaningful assessment is whether a strategy is generating superior returns relative to the level of risk it is taking.

Measures such as volatility, drawdowns and consistency of returns can therefore provide a better understanding of performance than a simple comparison with a broad-based benchmark. While benchmark selection remains important, the key question for investors is whether the manager is creating value efficiently rather than merely assuming higher levels of risk.

Tripathi adds that the benchmark “should match what the fund is actually doing—an equity, debt and hybrid strategy cannot be evaluated in the same manner.”

Investment product comparison

Checklist for understanding SIFs
What is the fund trying to do?
Generate higher returns?
Reduce downside?
Improve risk-adjusted returns?
Diversify existing portfolio?

How are derivatives used?
For hedging

• Protects downside
• Reduces volatility
• Tactical allocation
• Active positioning
• Higher flexibility
• Speculative leverage
• Directional bets
• Higher risk

Check the risk profile
Look for:

• Concentration
• Sector exposure
• Gross exposure
• Net exposure
• Liquidity
• Credit quality
• Portfolio turnover
• Drawdowns

The red flags

Investors should outright avoid certain things. According to Agrawal, there are three: an objective that promises consistent outperformance without a credible mechanism, a strategy description that relies heavily on jargon without explaining the actual mechanics, and leverage limits stated only as maximums with no disclosure of the typical or target leverage level.

Tripathi adds more: an objective and permitted strategy that don’t match; excessive reliance on recent performance in a category with no full-cycle record; and a mismatch between what the fund manager communicated and what the portfolio subsequently shows.

SIF red flags

• Strategy isn’t clearly explained
• Conservative objective
• Too much marketing language
• Vague derivative disclosure
• High concentration
• Portfolio doesn’t match stated objective
• Fund manager lacks experience

Is the manager the key?

In a mutual fund, process often matters as much as the person. In an SIF, that balance shifts.

For Agrawal, the manager is the process in an SIF. Tripathi’s first check is experience—a manager running long-short needs relevant experience in handling both long and short positions, and long-only experience doesn’t automatically establish expertise in it.

Gupta says investors should evaluate the broader investment platform behind a SIF rather than focusing solely on the individual fund manager. “The equity dealing team, research team; the entire team becomes important.”

Since most SIF strategies are relatively new and do not yet have long performance histories, investors can also look at the fund house’s pedigree in managing hybrid, arbitrage and other derivative-oriented strategies. The depth of the research platform, risk management framework and execution capabilities of the investment team can offer valuable insights into how effectively a SIF strategy is likely to be run.

One essential question

Selecting an SIF gets reduced to a single test: can you explain, in your own words, where this fund makes money, where it loses money, and why it belongs in your portfolio? In simple terms, understanding your fund’s strategy is crucial. If the answer to any of those is ‘no’, don’t invest yet. Be able to describe the strategy in two or three plain sentences, or stay out. If you cannot explain the source of returns, the primary risks and the role the product will play in your portfolio, you have not yet understood it well enough.

And the simplest filter of all: will this SIF actually improve your overall portfolio, either by enhancing long-term returns or by reducing volatility? If you cannot answer that, the product does not yet belong in your portfolio.