Investment strategies, leverage and complex trading strategies of Category III AIFs
What this domain tests
What Category III funds actually do, and how exposure - the basis of the leverage limit - is measured.
Strategy families
- Long-only listed equity, often concentrated and benchmark-agnostic.
- Long-short equity: longs partly funded by shorts, usually through derivatives.
- Arbitrage: cash-futures, merger, convertible and cross-listed arbitrage.
- Derivative overlays: index and stock futures/options for directional, volatility or hedging purposes, including unlisted derivatives.
- Event-driven and special situations, plus quantitative/systematic and high-turnover styles.
How leverage is counted
Leverage is not just borrowing: it includes notional exposure through derivatives. The ceiling is gross exposure of 2x NAV. Genuinely offsetting hedges are treated under the manager's stated policy, but directional positions cannot be relabelled as hedges. Leverage policy belongs in the PPM and must be monitored continuously, not only at trade entry.
Worked example
NAV Rs 50 crore. Long equity Rs 65 crore (130%) plus short index futures Rs 15 crore (30%). Gross exposure = 65 + 15 = Rs 80 crore = 1.6x, within the cap. Net exposure = 65 − 15 = Rs 50 crore = 1.0x, market-neutral in net terms. Maximum gross exposure is Rs 100 crore, so Rs 20 crore of gross can still be added - but only Rs 5 crore more net long if the net target is 110%. Adding to the short book raises gross exposure while lowering net exposure; that is the point candidates miss.
Traps
Treating shorts as reducing leverage; assuming only cash borrowing counts; confusing gross and net exposure; using margin paid rather than notional value to compute derivative exposure.