Sample Read
© NATIONAL INSTITUTE OF SECURITIES MARKETS, MUMBAI, 2026 PRINTING AND PUBLISHING RIGHTS WITH THE PUBLISHER All rights reserved. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of National Institute of Securities Markets. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. While every care has been taken in compiling the information contained in this publication, National Institute of Securities Markets accepts no responsibility for any errors or omissions. Workbook Version : March 2026 Price : ` 995 Published by : Taxmann Publications (P.) Ltd. Sales & Marketing : 59/32, New Rohtak Road, New Delhi-110 005 India Phone : +91-11-45562222 Website : www.taxmann.com, E-mail : sales@taxmann.com Mumbai 35, Bodke Building, Ground Floor, M.G. Road, Opp. Railway Station, Mulund (West), Mumbai-400080 Ph : +91-22-25934806, 25934807, 25934809; Mobile : 09322247686, 9619668669, 7045453844/45/48/51 E-mail : sales.mumbai@taxmann.com; nileshbhanushali@taxmann.com Regd. Office : 21/35, West Punjabi Bagh, New Delhi-110 026 India Printed at : Tan Prints (India) Pvt. Ltd. 44 Km. Mile Stone, National Highway, Rohtak Road, Village Rohad, Distt. Jhajjar (Haryana) India E-mail : sales@tanprints.com
DISCLAIMER The contents of this publication do not necessarily constitute or imply its endorsement, recommendation, or favoring by the National Institute of Securities Markets (NISM) or the Securities and Exchange Board of India (SEBI). This publication is meant for general reading and educational purpose only. The statements/explanations/concepts are of general nature and may not have taken into account the particular objective/move/aim/need/circumstances of individual user/reader/organization/institute. Thus NISM and SEBI do not assume any responsibility for any wrong move or action taken based on the information available in this publication. Therefore before acting on or following the steps suggested on any theme or before following any recommendation given in this publication user/reader should consider/seek professional advice. The publication contains information, statements, opinions, statistics and materials that have been obtained from sources believed to be reliable and the publishers of this title have made best efforts to avoid any errors. However, publishers of this material offer no guarantees and warranties of any kind to the readers/users of the information contained in this publication. Since the work and research is still going on in all these knowledge streams, NISM and SEBI do not warrant the totality and absolute accuracy, adequacy or completeness of this information and material and expressly disclaim any liability for errors or omissions in this information and material herein. NISM and SEBI do not accept any legal liability what-so-ever based on any information contained herein. While the NISM Certification examination will be largely based on material in this workbook, NISM does not guarantee that all questions in the examination will be from material covered herein.
CONTENTS PAGE
Foreword Acknowledgement About NISM Certifications About the Certification Examination for Alternative Investment Fund Managers Syllabus outline with Weightages
I-3 I-5 I-7 I-9 I-21
CHAPTER 1 INVESTMENTS LANDSCAPE 1.1 1.2 1.3 1.4
Investment Investment versus Speculation Investment Objectives Estimating the required rate of return
1 3 3 4
CHAPTER 2 TYPES OF INVESTMENTS 2.1 2.2 2.3 2.4 2.5 2.6
Traditional Investments v. Alternative Investments Types of Traditional Investments Types of Alternative Investments Channels for making investments Role of Alternative Investments in Portfolio Management Alternative Investments – Antecedents and Growth
17 20 22 27 29 32
I-13
CONTENTS
PAGE
CHAPTER 3 CONCEPT OF INFORMATIONAL EFFICIENCY 3.1 3.2 3.3 3.4 3.5
Informational Efficiency v. Operational Efficiency Efficient Capital markets and Random Walk Theory Tests and Results of Efficient Market Hypotheses (EMH) Market Anomalies Implication of market efficiency on Valuation and Portfolio Management
39 41 42 43 44
CHAPTER 4 INTRODUCTION TO MODERN PORTFOLIO THEORY 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11
Framework for constructing portfolios - Modern Portfolio Theory Assumptions of the theory Definition of risk averse, risk seeking and risk neutral investor Expected rate of return for individual security Variance of return for individual security (Ex-Ante Risk) Expected rate of return for a portfolio: (Ex-Ante Return) Variance of return for a portfolio Graphical Presentation of Portfolio risk/return of two Securities Efficient Frontier Portfolio Optimization process Estimation issues
49 50 50 52 52 53 54 56 57 58 59
CHAPTER 5 INTRODUCTION TO CAPITAL MARKET THEORY 5.1 5.2 5.3 5.4 I-14
Introduction to Capital Market Theory Assumptions of Capital Market Theory and the implication of relaxing these assumptions Capital Market Line Diversification of risk and market portfolio
63 64 65 71
CONTENTS
PAGE
5.5 5.6 5.7 5.8 5.9
71 72 74 75 76
Types of risk – Market and Non-market risk Capital Asset Pricing Model, CAPM Security Market Line Empirical test of CAPM Multi factor models of risk and return
CHAPTER 6 ALTERNATIVE INVESTMENT FUNDS IN INDIA AND ITS SUITABILITY 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8
Evolution and Growth of AIFs in India and Factors enabling preference for Indian AIF market Types of AIFs Comparison of Categories Suitability of AIF products to Investors Current AIF Market in India Comparison between Category III AIF and Traditional Investments Role of AIFs in Portfolio Diversification AIF as a Risk Management Tool
81 85 91 93 100 101 104 104
CHAPTER 7 ALTERNATIVE INVESTMENT FUND ECOSYSTEM 7.1
Concepts prevalent in the AIF industry
111
CHAPTER 8 ALTERNATIVE INVESTMENT FUND STRUCTURING 8.1 8.2 8.3 8.4 8.5 8.6
Principle of ‘Pooling’ General ‘Pooling’ Considerations Buy-out Transactions Anatomy of AIF Constitution Common Fund structures of AIF Comparative Analysis
144 145 147 150 153 161 I-15
CONTENTS
PAGE
CHAPTER 9 FEE STRUCTURE AND FUND PERFORMANCE 9.1 Management Fees and Other Expenses 9.2 Hurdle Rate 9.3 High-Water Mark 9.4 Risks in AIF 9.5 Types of Risks in AIFs 9.6 Risk Measures 9.7 Return Measures in Alternative Investments 9.8 Pre and Post Tax Returns 9.9 Risk-adjusted Return Metrics and Performance Measures 9.10 Worked out Case Annexure 9.1 : Template of Important Risk Factors at fund level and investor level
165 171 175 192 195 202 213 232 233 236 248
CHAPTER 10 INDICES AND BENCHMARKING 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8
Index Uses of Indices Factors differentiating the indices Index Methodologies Stock market indices Bond Market Indices Stock-Bond (Composite) Indices Performance Benchmarking
253 254 254 262 264 270 274 274
CHAPTER 11 INVESTMENT STRATEGIES, INVESTMENT PROCESS AND GOVERNANCE OF FUNDS 11.1 I-16
Investment Strategies used by Category I and II AIFs
287
CONTENTS
PAGE
11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 11.11
Investment Strategies used by Category III AIFs Deal Sourcing Investor Due Diligence Definitive Agreements Investor Protection Rights in Category I and II AIFs Regulation on Governance Structure in AIF Role of Human Capital in avoiding Conflict of Interests Co-investments in AIFs Code of Conduct of Investment Managers of AIFs and Investment Committee Industry best practices
298 319 324 327 328 338 349 352 353 355
CHAPTER 12 FUND DUE DILIGENCE – INVESTOR PERSPECTIVE 12.1 Fund Due Diligence 12.2 Investment Due Diligence by Investors 12.3 Manager Evaluation 12.4 Manager Selection 12.5 Key Man Clause 12.6 Due Diligence on other Legal Documents 12.7 Mitigation of Conflict of Interest Annexure 12.1 : Illustrative fund due diligence information and Questionnaire
359 362 367 369 372 373 375 376
CHAPTER 13 LEGAL DOCUMENTATION AND NEGOTIATIONS 13.1 13.2 13.3 13.4 13.5
Introduction The Trust Document/Limited Liability Partnership Deed/Memorandum and Articles of Associations The Investment Management Agreement The Subscription (Investor Contribution) Agreement Private Placement Memorandum
385 386 387 388 390
I-17
CONTENTS
PAGE
13.6 Wrapper 13.7 Support Services Agreements Annexure 13.1 : Investor Charter for Alternative Investment Funds
402 402 408
CHAPTER 14 VALUATION 14.1 14.2 14.3 14.4 14.5 14.6 14.7 14.8 14.9 14.10 14.11 14.12 14.13 14.14 14.15
Introduction Valuation Basics for Fixed Income Instruments Approaches to Equity Valuation Approaches to Business Valuation Asset based Valuation Discounted Cash Flow (DCF) Valuation Relative or Multiple based Valuation Valuation of AIF Portfolio Investments (Investee Companies) General Approach to Fund Valuation Net Asset Value (NAV) Valuation Techniques Computation of NAV for a Category III AIF v. NAV attributable to a series of units issued to investors Valuation Regulations Role of third-party Registered Valuers Reporting of value of units of AIFs
415 416 418 418 420 423 428 432 438 439 450 466 473 474 476
CHAPTER 15 FUND MONITORING, REPORTING AND EXIT 15.1 15.2 15.3 15.4 15.5 15.6 15.7 15.8 I-18
Monitoring Alternative Investment Fund Progress and Performance Regulatory Framework for Fund Monitoring and Reporting Fund Reporting Exit Options Secondary Exits (Secondaries) Winding Up of an AIF Liquidation Scheme Dissolution Period
479 481 490 492 498 498 500 504
CONTENTS
PAGE
CHAPTER 16 TAXATION 16.1 16.2 16.3 16.4 16.5 16.6 16.7 16.8
Taxation of Category I and Category II AIFs Taxation of Category III AIF Surcharge Rates Set off and carry forward of loss under the ITA GAAR MLI Other applicable taxes Examples
507 532 545 547 549 550 551 552
CHAPTER 17 REGULATORY FRAMEWORK A. SEBI (Alternative Investment Funds) Regulations, 2012 17.1 17.2 17.3 17.4 17.5 17.6 17.7 17.8 17.9 17.10 17.11 17.12 17.13 17.14 17.15
Registration Process and Eligibility Criteria Sponsor/Manager Commitment Concept of Open-ended and Close-ended Funds Accredited Investor Framework First Close, Final Close and Tenure of Funds/Schemes Investors’ subscription to the Fund/Scheme Dematerialization of AIF Units Raising Corpus Capital Investment Conditions applicable to AIFs Guidelines on Operational, Prudential and Reporting Norms for Category III AIFs General Obligations and Responsibilities of AIFs Inspection Code of Conduct for AIFs Market Surveillance by AIFs Exemption from enforcement of the regulations in special cases
560 568 569 570 575 578 579 580 583 603 607 610 611 611 612 I-19
CONTENTS
PAGE
17.16 17.17
Periodic Disclosures and Reporting Specific due diligence of investors and investments of AIFs
612 613
B. Foreign Exchange Management Act, 1999 17.18 17.19 17.20 17.21 17.22
FDI and its Economic Significance Investment Framework under FEMA Inbound Foreign Investment Routes Foreign Investments in AIFs Overseas Investments by AIFs
618 619 622 624 627
C. Prevention of Anti-Money Laundering Act, 2002 17.23
Regulatory Oversight
629
D. Other related SEBI Regulations 17.24 17.25 17.26 17.27 17.28
SEBI (Prohibition of Insider Trading) Regulations, 2015 SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003 SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 SEBI (Foreign Portfolio Investors) Regulations, 2019 Foreign Account Tax Compliance Act and Common Reporting Standard
GLOSSARY
I-20
633 637 638 641 642 647
CHAPTER 4 INTRODUCTION TO MODERN PORTFOLIO THEORY LEARNING OBJECTIVES: After studying this chapter, you should know about: ¾ The framework for constructing and selecting portfolios ¾ Calculation of risk and return of individual asset/security ¾ Calculation of risk and return of a portfolio of assets/securities ¾ Benefits of diversification
4.1 Framework for constructing portfolios - Modern Portfolio Theory Conventional wisdom has always dictated not putting all the eggs in one basket. This adage is addressing the benefits of diversification. Prior to 1950, investing community was familiar with the benefits of holding a diversified portfolio. However, they had no way of quantifying the benefits of diversification. In 1952, the Journal of Finance published an article titled “Portfolio Selection”, authored by Harry Markowitz. Decades later in 1990, Harry Markowitz was honoured with the Nobel Prize in Economics for his ‘Portfolio Theory’. The ideas introduced in this article have come to form the foundations of what is now popularly referred as Modern Portfolio Theory (MPT). In simple words, MPT provides a framework for constructing and selecting portfolios based on the expected performance of the investments and the risk appetite of the investor. MPT quantified the concept of
49
INTRODUCTION TO MODERN PORTFOLIO THEORY
diversification by introducing the statistical notion of covariance, or correlation between investment assets. Harry Markowitz mathematically demonstrated that the variance of the rate of return is a meaningful measure of portfolio risk. He derived the formula for computing the variance of a portfolio, showing how to effectively diversify a portfolio.
4.2 Assumptions of the theory Some of the assumptions of the Modern Portfolio Theory (MPT) are as under: ¾ An investor wants to maximise the return for a given level of risk. That means
given a choice between two assets with equal rate of return, investors will select the asset with lower risk. ¾ Investors consider each investment alternative as being presented by a probability
distribution of expected returns over some holding period. ¾ Investors maximise one-period expected utility. Investors choose an action
or event with the maximum expected utility. Investors assign utility scores to the various portfolio choices available to them. ¾ Investors base decisions solely on expected return and risk. ¾ Investors estimate the risk of the portfolio on the basis of the variability of
expected returns of constituent assets.
4.3 Definition of risk averse, risk seeking and risk neutral investor The presence of risk means that more than one outcome is possible. Investors demand risk premium for bearing the risk. The question whether a given risk premium is adequate is a central theme in investment management. Measurement of risk and determination of risk premium is an important area of work in finance. Risk averse investors will invest in risk-free investment opportunities or in investment opportunities with positive expected risk premium. The greater the risk, greater the demand for risk premium. Investors assign utility score to competing portfolios given their expected return and risk involved. Utility scores are assigned to those portfolios for their risk-return profile. Higher utility scores are assigned to portfolios with higher expected return and lower risk, and lower utility scores are assigned 50
INTRODUCTION TO MODERN PORTFOLIO THEORY
to portfolios with higher risk and lower returns. A function commonly used by financial experts assigns a portfolio with expected return E(r) and variance of the return the following utility score: U = E(r) - ½ AV2 Where: U is the utility value, A is an index of investor’s risk aversion. V2 is the variance of the returns of the investment. Say for instance an investor has a risk aversion index of 3 and is evaluating an investment alternative that generates an expected return of 15%, with a variance of 10%. The ongoing risk free rate of return is 8%. Then to decide to invest or not, the investor can calculate the Utility score as follows: U = 0.15 - (0.5 × 3 × 0.10 × 0.10) = 0.135 or 13.5% OR to avoid the usage of decimal forms of returns and variance the ½ (scaling convention) can be adopted as 0.005 and the values of returns and variance can be used without the percentage decimal form as follows to get the direct Utility answer. U =15 – (0.005 × 3 × 10 × 10) = 13.5% Now typically an investor would compare this Utility with the risk free rate of return, because that is the comparable risk free investment. In the above, case we have assumed that the ongoing risk free rate of return is 8%, and therefore the excess Utility is 13.5% - 8% = 5.5%. Because Utility of the investment is greater than the risk free rate of return, the investor should choose this investment. It may be noted that the above equation supports the thought process that utility is enhanced by expected return and reduced by risk. The return generated by a particular investment alternative is penalised for the risk involved according to the unique risk aversion of the investor. Therefore, Utility is indirectly measuring the risk free return of that investment. So, logically, if Utility is greater than the risk free rate, the investment is worthwhile investing. It is interesting to note that Utility is not like risk reward ratio or Sharpe Ratio, which also measures the excess return of a portfolio over its risk. In the risk to reward ratio or Sharpe Ratio, there is no involvement of investors’ risk aversion. It goes by the assumption that every investor is similar and their risk perceptions about an investment are homogenous. Therefore, higher the Sharpe Ratio better the investment is. But in the practical world, a good portfolio or investment is not equally attractive to all the investors. What explains this heterogeneity? The answer to this question is Utility that explains that it is the unique individual risk aversion, which makes investors differ in their choices. 51
INTRODUCTION TO MODERN PORTFOLIO THEORY
4.4 Expected rate of return for individual security Expected rate of return of an individual investment opportunity is the sum of the expected returns multiplied with their corresponding probabilities. Such a return is also known as Ex-Ante Return. Returns which are calculated based on historical data are called as Ex-Post Returns. Suppose the following returns are forecasted for stocks A and B in the three possible scenarios (Table 4.1): TABLE 4.1 EXPECTED RATE OF RETURN FOR A SECURITY
I II III
State Boom Normal Recession
Probability 0.3 0.5 0.2
A 15% 10% 2%
B 25% 10% 1%
The expected return of these two stocks will be calculated as follow: RA = 0.3(15%) + 0.5(10%) + 0.2(2%) = 9.9% RB = 0.3(25%) + 0.5(20%) + 0.2(1%) = 17.7%
4.5 Variance of return for individual security (Ex-Ante Risk) Risk of investing in an asset is defined as the variability in its return. One of the best-known measures of risk is standard deviation of expected returns (square root of variance of expected returns). It is a statistical measure of the dispersion of returns Ri around the expected value [E(Ri)]. Larger variance (larger standard deviation) indicates greater dispersion, hence larger risk. n
Variance (V2) = ∑ [R i − E(R i )] 2 Pi i =1
where Pi is the probability of the possible rate of return, Ri The calculation of Variance of an individual security is shown below in Table 4.2: The square root of this measure is known as Ex-Ante Risk.
52
INTRODUCTION TO MODERN PORTFOLIO THEORY TABLE 4.2: VARIANCE OF AN EXPECTED RATE OF RETURN FOR A SECURITY
Return of a Expected Ri-E(Ri) security in a Rate of Reparticular state turn E(Ri) of forecast Ri 8% 11% -3% 10% 11% -1% 12% 11% 1% 14% 11% 3%
(Ri-E(Ri))2
P
0.0009 0.25 0.0001 0.25 0.0001 0.25 0.0009 0.25 Variance as an aggregate of the last column
(Ri-E(Ri))2 *P
0.000225 0.000025 0.000025 0.000225 0.0005
Expected Rate of Return = (8% × 0.25) + (10% × 0.25) + (12% × 0.25) + (14% × 0.25) = 11% Ex-Ante or Expected Variance = 0.00050 Ex-Ante or Expected Standard Deviation = 0.0224 or 2.24% (Square Root of Variance)
4.6 Expected rate of return for a portfolio: (Ex-Ante Return) Expected rate of return for a portfolio of assets is the weighted average of the expected rates of return for the individual investments in the portfolio. n
E(R por i) = ∑ Wi R i i=1
where : Wi = the percent of the portfolio in asset i E(Ri) = the expected rate of return for asset i The calculation of the portfolio return is shown below in Table 4.3. TABLE 4.3: CALCULATION OF PORTFOLIO RETURN WITH 4 ASSETS IN IT.
Weight of Asset in portfolio 0.2 0.1
Expected Return of the Asset 0.09 or 9% 0.12 or 12%
Weighted investment Return 0.018 0.012 53
INTRODUCTION TO MODERN PORTFOLIO THEORY
Weight of Asset in portfolio 0.3 0.4
Expected Return of the Asset 0.15 or 15% 0.18 or 18% Expected Return of the Portfolio
Weighted investment Return 0.045 0.072 0.147 or 14.7%
4.7 Variance of return for a portfolio Harry Markowitz derived the variance of a portfolio investment by using the statistical notions of covariance or correlation. Box 4.1 explains the difference between covariance and correlation. Box 4.1: Covariance or Correlation Covariance is a measure of the degree to which two variables “move together” relative to their individual mean values. For two assets, i and j, the covariance of rates of return is defined as: n
Cov ij ∑ [R i − E (R i )][ R j − E ( R j )] / n i =1
The correlation coefficient is obtained by standardising (dividing) the covariance by the product of the individual standard deviations. Cov ij rij = σ iσ j where: ij = the correlation coefficient of returns OT = the standard deviation of Rit
V j = the standard deviation of Rjt Correlation coefficient varies from -1 to +1. A value of +1 would indicate perfect positive correlation. This means that returns for the two assets move together in a completely linear manner. A value of –1 would indicate perfect negative correlation. This means the returns of the two assets move in opposite direction.
Markowitz derived the general formula for the risk of the portfolio returns as follows: where: σ port =
n
i =1
54
n
n
∑ w σ ∑∑ w w Cov 2 i
2 i
i
i =1 i =1
j
ij
INTRODUCTION TO MODERN PORTFOLIO THEORY
V-port = the standard deviation of the portfolio
Wi = the weights of the individual assets in the portfolio, where weights are determined by the proportion of value in the portfolio σ i2 = the variance of rates of return for asset i
Covij = the covariance between the rates of return for assets i and j, where Covij = rijViVj As can be seen, portfolio risk takes into consideration the weights of every investment in the portfolio, their individual risks (standard deviation) and the correlated risks between each pair of constituent assets. In other words, variables which affect the portfolio risk are: 1. weights of investments 2. risk of investments 3. co-movement between investments TABLE 4.4: PORTFOLIO RISK CALCULATION FOR TWO SECURITIES
Correlation coefficient between the returns of Security A and B Expected Return on Security A Standard Deviation of return of Security A Expected Return on Security B Standard Deviation of return of Security B Weight of security A Weight of security B
0.50 0.15 0.05 0.15 0.05 0.50 0.50
Portfolio Variance 2 σ port = w12σ 12 + w 22σ 22 + 2w1w 2 r1,2σ 1σ 2 2 σ port = (.502 × 0.052) + (.502 × 0.052) + (2 × .50 × .50× .5 × .05 × .05) 2 σ port = 0.001875 2 σ port = 0.0433
55
INTRODUCTION TO MODERN PORTFOLIO THEORY
4.8 Graphical presentation of portfolio risk/return of two securities If two securities are perfectly correlated, all the possible combinations of these two assets are represented by a straight line connecting the returns of these securities on a graph where the returns are plotted on the y-axis and risks on the x-axis. The line contains portfolios of these two investments formed by changing the weights of each security invested in the portfolio. The graph in Exhibit 4.1 clearly depicts that there was no possibility to create a portfolio, that generates a higher return than that of security B, or a lower risk than that of security A. Indirectly conveying that there is no benefit due to combining them in any proportion. It also means that there was no possibility for risk diversification when two assets having perfect positive correlation between them are combined to form a portfolio. This is a very fundamental understanding in the Modern Portfolio Theory. EXHIBIT 4.1: RISK-RETURN PLOT FOR A TWO SECURITIES PORTFOLIO
Now let us examine what happens when correlation between the two securities is less than 1. If the two securities are not perfectly correlated, the portfolio’s risk is less than the weighted average risk of the securities, and the portfolio formed from the two securities bulges to the left as shown by the curves with the correlation coefficient (U) less than 1.0. With low (less than +1 correlation) or negative correlation it is possible to derive portfolios that have lower risk than either of the assets. This is the essence of diversification. As long as the correlation is less than perfect 1, benefits of diversification occurs. Lower the correlation, higher the benefits of diversification. Exhibit 4.2 demonstrates the portfolio risk–return plots for different weights when ri,j = +1.00; +0.50; 0.00; -0.50; -1.00 56
INTRODUCTION TO MODERN PORTFOLIO THEORY EXHIBIT 4.2: RISK-RETURN PLOT FOR A TWO SECURITIES PORTFOLIO (WITH DIFFERENT CORRELATION ASSUMPTIONS)
As can be noted in the graph in Exhibit 4.2, when the correlation between the two assets is -1, the complete benefits of diversification is realized. The negative correlation term is completely offsetting the combined variances terms. Hence, a unique combination of such perfectly negatively correlated securities could yield a zero risk portfolio. As noted, the benefit of diversification is critically dependent on the correlation between assets.
4.9 Efficient Frontier The risk/return of a portfolio with above two securities can be plotted for all the possible weight combinations. When the correlation between them is less than perfect 1, the various combinations of them get plotted on a curve (Exhibit 4.3). EXHIBIT 4.3: POSSIBLE PORTFOLIO COMBINATIONS OF TWO SECURITIES
Similarly, many more securities can be combined in various (theoretically infinite) combinations and can be plotted accordingly. Of the various combinations, the one 57
INTRODUCTION TO MODERN PORTFOLIO THEORY
that offer highest return for a given level of risk or the lowest risk for a given level of return will appear to be like an umbrella shaped curve. This umbrella shaped curve is referred as Efficient Frontier (Exhibit 4.4). EXHIBIT 4.4: EFFICIENT FRONTIER
The efficient frontier represents set of portfolios that provides maximum rate of return for a given level of risk or the minimum risk for a given level of return. As can be seen in the above graph every portfolio that lies on the efficient frontier has highest possible rate of return for a given level of risk. For example, portfolio A stands on efficient frontier as against portfolio C, because portfolio C has the same rate of return of portfolio A but much higher risk. Similarly, portfolio B also stands on the efficient frontier, because it has a higher return than C, with the same risk.
4.10 Portfolio Optimization process An optimum portfolio is a combination of investments having desirable individual risk– return characteristics for a given set of constraints. For using the Modern Portfolio Theory framework for constructing and selecting the portfolio, the portfolio manager is required to estimate the following: 1. The expected return of every asset class, securities and investment opportunities which are part of investment universe. 2. The standard deviation of each asset’s expected returns. 3. The correlation coefficients among the entire set of asset class, securities and investment opportunities, taking a pair of them at a time. In addition to these inputs, if the investor has any constraints, the same also needs to be specified. Exhibit 4.5 illustrates the portfolio optimization process. 58
Alternative Investment Fund Managers AUTHOR : PUBLISHER : DATE OF PUBLICATION : EDITION : ISBN NO : No. of Pages : BINDING TYPE :
NISM | An Educational Initiative of SEBI Taxmann September 2026 Workbook Version - March 2026 9788167011718 676 Paperback
Rs. 995 DESCRIPTION Alternative Investment Fund Managers is a complete working treatment of Alternative Investment Funds in India, covering how an AIF is structured, priced, governed, valued, monitored, taxed, wound up and regulated. Published by Taxmann as the official NISM workbook, it serves equally as a desk reference for anyone who manages, advises, services or invests in an AIF. The distinguishing feature is that the subject is computed, not merely described. Fee waterfalls, IRR and PME, NAV determination and tax liability are worked through with figures, and every regulatory proposition is footnoted to the amendment or circular it comes from. It is also the prescribed study material for the NISM-Series-XIX-C: Alternative Investment Fund Managers Certification Examination, the certification SEBI has notified for the key investment team of an AIF Manager. This book is intended for the following audience: • Fund Managers and Key Investment Team Members • Sponsors, Trustees, Compliance Officers and Investment Committee Members • Fund Operations and Reporting Teams • Merchant Bankers, Custodians, RTAs, Fund Accountants, Registered Valuers and Legal and Tax Advisers • Institutional Allocators, Family Offices and HNI Investors • Wealth Managers, RIAs and Distributors • Chartered Accountants, Company Secretaries, Advocates, CFA Candidates and MBA (Finance) Students • Candidates for the NISM-Series-XIX-C Examination The Present Publication is the March 2026 Workbook Version. It is developed in collaboration with the Certification Team of NISM, Archit Lohia, Pratap Giri and Dr Rachana Baid and reviewed by Biharilal Deora and Taxmann’s Editorial Board. It is published exclusively by Taxmann, with the following noteworthy features: • [Complete Coverage in One Volume] Portfolio theory to statutory detail, written so that a commercial term introduced in one chapter is computed in another and traced to its regulatory source in a third • [Full Life-Cycle Fund Case] An eight-year close-ended fund worked in twelve steps, from cash flows and gross and net fund IRR through the J-curve, hurdle rate distribution and the distribution waterfall to investor-level net IRR • [48 Worked Examples and Illustrations] Including NAV and Series NAV computation for a Category III AIF, index construction under three weighting methods, and three taxation examples worked at fund and unitholder level • [Three Practitioner Annexures] A fund-level and investor-level risk factor template, a fund due diligence questionnaire, and the Investor Charter for AIFs, each drafted for direct use • [Comparative Analysis in 21 Tables] The three AIF categories, Category III against PMS and mutual funds, and domestic, offshore, parallel and unified structures set side by side • [Amended & Updated] Circular references running to 4 March 2026, covering the pro-rata and pari-passu framework, the dissolution period, the liquidation scheme and the specific due diligence obligations
• [Built-in Study Apparatus] Learning Objectives opening every chapter, self-assessment questions closing every chapter, and a glossary of private equity and venture capital terms
Buy Now