Kaveri Opportunities: Choosing a category when strategy mixes yield options and revolving borrowing
Promoter group Kaveri Capital Partners plans the 'Kaveri Opportunities Fund', an INR 60 crore scheme to buy unlisted equity in mid-market manufacturers. The draft term sheet also proposes (i) writing covered call options on the Nifty 50 to add 2–3% annual yield, (ii) borrowing up to 15% of the scheme's investable funds on a revolving basis to close deals faster, and (iii) onboarding 1,200 investors at the INR 1 crore minimum. The vehicle will be an LLP, and the manager wants a three-year term with two one-year extensions at its own discretion. The placement team argues the fund is 'Category II because 85% of assets will be unlisted equity', and that the option-writing is 'only hedging'. Compliance has been asked to sign off the placement memorandum this week. The sponsor is also keen to avoid a Category III label because it believes investor onboarding and reporting will be slower.
1. Which category can the scheme be registered in, and what has to change before the placement memorandum can go out?
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Category is decided by the strategy's risk features, not by the percentage of unlisted assets.
- Option-writing for yield is not hedging. A Category I or II fund may use derivatives only for hedging; selling index calls to generate return is a Category III activity.
- Revolving borrowing at 15% of investable funds is leverage, not temporary funding. A Category I/II fund may borrow only for temporary funding needs, for up to 30 days, on not more than four occasions a year, and up to 10% of investable funds. The proposal fails on all three.
- The INR 20 crore minimum corpus is met at INR 60 crore, and an LLP is a permitted vehicle.
- Investor cap: 1,200 investors fails even in Category I/II (1,000 cap) and is impossible in Category III (500 cap).
So the choices are: strip out the yield options and revolving borrowing, register Category II, and cut the investor base to 1,000 or fewer; or keep the strategy, register Category III with leverage consent from investors, a 2x-of-NAV leverage ceiling and full disclosure, and limit the scheme to 500 investors. Compliance should not sign off a document that mislabels leverage.
2. Can the manager extend the fund's tenure twice on its own, and how should the extension be handled?
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No. Tenure and extension mechanics are fundamental terms of a close-ended scheme and must be disclosed in the placement memorandum; the manager cannot grant itself rollovers.
A close-ended AIF has a minimum three-year tenure. Any extension beyond the disclosed term must follow the fund documents and be approved by investors in the manner the regulations and documents prescribe, with disclosure of the reasons, the revised exit route, any change in strategy, and the fee implications of holding assets longer. If the extension is intended to be available, the maximum term and the approval route must appear in the placement memorandum at launch, not be discovered at maturity.
Operationally: put a specific proposal to investors (length, fees, expected realisations, distributions already made), obtain consent in writing, and if consent is not obtained, begin an orderly wind-down and distribution rather than continuing to hold assets. Unilateral extension would also distort the NAV and exit expectations of investors who subscribed on a three-year basis.
3. Suppose the sponsor drops the options and borrowing, caps investors at 900, and registers as Category II - but later wants to sell options 'opportunistically' when markets are rich. What is the issue and what process applies?
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The scheme would then be drifting outside its registered category and its disclosed strategy. A Category II fund cannot start writing options for yield merely because the manager sees an opportunity; derivatives remain limited to hedging, and the placement memorandum and investor consent define what the scheme may do.
If the strategy genuinely changes, treat it as a material change: obtain investor consent as required by the regulations and fund documents, amend the placement memorandum and disclosures, and apply to SEBI for approval of any change of category, including consequential changes to registration, reporting, leverage permissions and continuing-interest requirements. A Category II to Category III shift is not a filing formality; it changes the investor base cap, leverage ceiling and risk disclosures.
Governance point: the investment committee should have a pre-trade test against the registered category, and compliance should document any breach rather than reinterpret the strategy after the trade. Opportunistic risk-taking outside the mandate is also a fiduciary problem, not just a regulatory one.