Venture Capital

Constructing a portfolio of mutual funds is not an easy exercise. It is important to diversify the portfolio so that a retail investor has exposure to the broad market. Yet, the portfolio should be small for ease of monitoring.

This article is about such a tightly-constructed portfolio of mutual funds. The suggested portfolio may be optimal for retail investors whose investment is less than Rs 10 lakh or whose investment through Systematic Investment Plan (SIP) is less than Rs 50,000 per month. The core portfolio exposure will be in large-cap index funds. The satellite portfolio will be in mid-cap active funds, fixed maturity bond funds and emerging market funds.

Core Portfolio
It is always tempting to take exposure to active funds to constitute the core portfolio. After all, most active funds beat the large-cap index when the market trends up. The problem, however, is that active funds do not consistently outperform markets (generate alpha returns).

Portfolio managers generate alpha returns either through security selection and/or market timing. Generating alpha through security selection is difficult within the large-cap space due to the deluge of public information and the small universe of investible stocks.

But that is not the only reason for investors to consider taking exposure to index funds. Take active (diversified) funds that follow multi-style investing. Generating alpha in such cases requires good tactical asset allocation skills such as shifting between large-caps and mid-caps. It is moot if funds can beat the broad market index such as S&P CNX 500. Moreover, buying a multi-style active fund as part of the core portfolio and a sector fund or single-style fund for the satellite portfolio may result in over-exposure to a market sector. Why?

According to a study conducted by PHDCCI, the assets under management (AUM) with mutual funds could expect a moderate slowdown by the end of this fiscal and may drop below Rs 5 lakh crore.

However, the AUM of Indian mutual funds have the potential to grow by three times to Rs 15.6 lakh crore by 2012-13, powered by strong economic growth and better distribution.

The analysis shows that industry's AUM has consistently dropped - from Rs 5.95 lakh crore in April to Rs 5.88 lakh crore in May and Rs 5.6 lakh crore in June this year. The month of July has yet again witnessed a further drop in AUM to Rs 5.29 lakh crore, which is more than 6 per cent lower than the previous month. One of the reasons attributed to the declining performance in the mutual funds industry is lack of investor support in equity-based funds, which has shrunk by nearly a third riding on the back of uncertainty and steep decline in Sensex.

If implemented, it would be another major step to monitor the flow of foreign capital into the country. The broadening of the class of investors under FDI nomenclature comes at a time when there is growing debate over the role of sovereign wealth funds and the influence they wield on economies, globally.

Besides private equity and foreign venture capital, RBI wants to include foreign nationals, foreign Companies, FIIs registered with Sebi, foreign trusts and other funds, pensions/provident funds, partnership/proprietorship firms, FIs and NRIs/PIOs among those who have to report investment under the existing FDI framework.In addition, details of investment received from foreign venture capital investors are also proposed to be captured separately. Part B of Form FC-GPR has been modified to capture details of such foreign investors. The date of filing Part B of the form has been extended from June 30 of every year to July 31.

FDI is permitted under the automatic and government/ approval route. An Indian company issuing shares and convertible debentures to non-residents under either route is required to submit details of the investment in a two-stage reporting procedure.

In the first stage, receipt of funds is to be reported to RBI within 30 days. In the second stage, the company has to file Form FC-GPR with RBI within 30 days from the date of issuing shares/convertible debentures.

In order to capture the details of FDI in a more comprehensive manner, the earlier Form FC-GPR was revised in April 2007 by which banks in India receiving foreign remittances for the issue of shares were required to obtain a Know Your Customer report on the foreign investor from the overseas bank remitting the amount.

The Hyderabad-based realty company will be divesting a minority stake to Infinite India, which is amongst the largest real estate-focused investment firms in the country.

Maytas Properties plans to channel the funds to develop the Phase II of its Maytas Hill County in Hyderabad as well as for upcoming projects in Chennai, Bangalore, Nagpur, Hyderabad, Vijayawada, Visakhapatnam and Kochi in the next six months.

The realty company from the family of the promoters of Satyam Computer Ltd is planning to develop 9 million square feet IT SEZ (special economic zone) and 28 million sq.ft of residential space in the Maytas Hill Country phase-II, a company press release said.

Maytas Hill County Phase I, which is nearing completion, is an integrated township project with an IT SEZ. It has a combination of apartments, villas and bungalows. The company recently got all the quality certifications for realty.

The Chief Executive Officer, Mr K. Thiagarajan, said the private equity investment will give the necessary momentum for expansion plans and fund the projects. It will also give access to the fund's network and expertise in the real estate sector.

Infinite India Investment Management is a joint venture between the US-based, SRS Investments and the JM Financial Group. For the firm, investment in Maytas is its biggest, after their recent commitment of about Rs 200 crore in a leading real estate player in the eastern region, according to the Chairman of Infinite India, Mr Karthik Sarma.

Panel moderator Richard Wallace, vice president and group editorial director at CMP Media, publisher of EE Times, said improving infrastructure, looser financial controls and the movement from a services- to a product-oriented domestic market all point to greater investment in product start-ups.

"There is also a huge upside for energy and medical equipment-related products that can potentially address the huge segment of the less well-off population," Wallace said. "India has hungry entrepreneurs who I expect will change the face of the country in 5 to 10 years from now."

Pradeep Tagare, senior investment manager at Intel Capital India, said 50 new VC firms set up shop in India during 2007. The total number of venture capital and private equity companies in India is about 500, Tagare said.

Of the $750 million in Indian venture funding during the first nine months of 2007, two-thirds were early stage investments. Half of all investments were less than $5 million each. "Mergers and acquisitions [are] growing in number, and Indian firms [are] now raising capital solely for acquiring companies in Europe and the U.S," Tagare said. "This will grow at a faster clip in the next three to four years. But, there are few or no venture funds raised by semiconductor or electronic product " related companies."

Pashupathy Gopalan, vice president of strategic marketing and corporate business development at Cypress Semiconductor (San Jose, Calif.), said its investment fund targets such projects as motors for electric bikes, LED lighting, solar power and the Indian automotive and consumer electronics.

"The problem in India is that while it has an ocean of engineering talent, the people who can meet potential customers and understand them is lacking," Gopalan said. Top Indian design teams have "the potential to launch a start-up, but preferred to get a regular amount of money each month than make the jump."

Sanjay Nayak, chief executive of one of India's few product manufacturers, Tejas Networks, predicted that the recent trend involving expansion here by multinational manufacturers will be overtaken in the next several years by the rise of product start-ups.

The shift will be aided by a growing domestic market. The wireless explosion and the imminent rollout of retail stores here presents opportunities for product companies, Nayak added. "R&D costs in India are about a fourth of that in the U.S., so we had more [left] to innovate." Added Nayak: "We got to profitability after investing just $30 million, while at least $150 million would have been needed to get to this stage if we had been in the U.S."

"The successful model of Tejas, whose model is different from that of successful companies in the U.S., could set the trend for more start-ups" in India, Wallace added.

The fund has been put on hold by the Foreign Investment Promotion Board (FIPB). Former RBI deputy governor Vepa Kamesam, Lt Gen VJ Sundaram, who is leader of the flight vehicle design team for Prithvi, and Tata Strategic Electronics CEO Rahul Chowdhry are on the advisory board of the fund.

A lack of clearance from the defence ministry and "a potential conflict of interest" with the advisors of the company are cited to be the reasons behind the hold-up. This is the first time that a venture fund of such size is being set up for investments in defence SMEs. The move comes at a time when multinationals are vying for multi-billion dollar defence deals from the Indian government, which also include mega orders for fighter aircraft.

The fund is promoted by Rajesh Narayan, who was earlier a director and India head (specialist finance) at ANZ Investment Bank. The segments of investment identified by the fund include military aircraft, helicopters, radars, submarines, missiles, rocket launchers, simulators, tanks and torpedoes. Investment would be made in SMEs that are vendors for these products. Many SMEs supply components, technology and designs for such products.

The fund plans to raise $100 million (Rs 400 crore) initially with subscriptions from foreign investors, keeping provisions to scale up investments by $200 million (Rs 800 crore). Christened India Rizing Fund, the venture capital fund has informed FIPB that it would also look at other sectors at a later stage. Since issue of units to foreign investors by venture capital funds requires clearance by FIPB, the matter was taken up recently, but held up for the defence ministry's views.

During discussions by the board, it was pointed out that there could be a situation of potential conflict of interest due to the composition of the board of advisors. The obvious reference was to members involved in development of defence equipment and strategic electronics used in defence applications, government sources said.

Although norms framed by stock market regulator Sebi and corporate governance tenets would take care of the conflict situation, it was suggested that the more important issue was the lack of clearance from defence authorities. FIPB then referred the matter to the defence ministry before taking a final call.

The home ministry has cleared the proposal and conveyed that there were no adverse remarks about the organisation or its advisory board from the security angle. The departments of economic affairs and industry policy & promotion have also cleared the proposal.

It is understood that FIPB would take up the proposal after obtaining the views of the defence ministry on the implications of allowing a VC fund with foreign money to invest in companies dealing with defence products. There is s feeling that investment in this segment has come into focus since multinationals bagging huge orders from India are looking at local sourcing to meet trade commitments.

Of these deals, nearly 48 per cent were for Information Technology (IT) companies, as 38 rounds were completed, accounting for $384 million (around Rs 1,500 crore -- more than India's 2006 venture investment total).

The most popular recipients of venture capital in the IT industry were companies in the web-heavy "information services" sector, which accounted for 22 deals and nearly $141 million (around Rs 560 crore) in investment.

Among the deals in this area was the $10 million second round for Bangalore-based Four Interactive, an online provider of local information on food, events, lifestyle, shopping and more.

"Service-oriented companies in India -- both in the technology fields and the non-technology areas of hotels, taxis and similar services -- continue to attract investment and this is likely due to their low capital requirements as well as to the rapidly emerging nature of the broader Indian economy," said Jessica Canning, Director of Global Research for Dow Jones VentureSource.

"It takes relatively little money and little time for these kinds of companies to begin generating revenues and, because of this, web-related and consumer and business services companies accounted for more than half of all the venture capital deals done in India in 2007."

According to the data, the business, consumer and retail segments saw 30 deals completed in 2007 and more than $346 million invested -- a 92 per cent jump over the $180 million invested in 16 deals in the industry in 2006.

As said, the business/consumer service area accounted for the bulk of the interest in this industry, with 22 deals and $254 million invested.

India's healthcare industry, while still in its infancy, also saw increased investor interest in 2007 with seven completed deals and nearly $100 million invested, more than double the $41 million invested in the prior year.

"This is only the beginning for the venture capital market in India," said Canning.

Venture Capital is a source of financing for companies wish to enter into new or turnaround ventures. Venture capital means more risky money i.e. money used in risky enterprises. For instance, innovative, high-tech ideas are risky and so is the money invested in these ideas. As such projects have high mortality rates, risk averse bankers and private sector financiers avoid providing capital for such ventures. But it is venture capitalists who provide necessary funds often alongwith management and marketing assistance. After some years, when assisted company reaches a certain stage of profitability, the venture capitalists sells its shares at substantial premium. The venture capitalist thus makes profits and gets back the locked up funds for re-deployment in some other venture.

Some of the important definitions relevant to understand venture capital financing are given below:

Venture Capital Company- Such company as has made investments by way of acquiring equity shares of venture capital undertakings which require funds/capital. The term `venture capital company' as defined in clause 23(FB) of section 10 of Income -tax Act is reproduced below:

As of 2006 some of the best-known VC Firms are:

    * Kleiner, Perkins, Caufield and Byers
    * Sequoia Capital
    * Mayfield Fund
    * BA Venture Partners
    * Accel
    * New Enterprise Associates
    * Benchmark Capital
    * Menlo Ventures
    * Draper Fisher Jurvetson
    * Highland Capital Partners
    * Venrock Associates