The Impact of Rupee Depreciation on Overseas Investors in PE Funds
Recently, the rupee’s depreciation against the dollar has sparked concerns among investors in domestic private equity funds. This shift in currency values could potentially affect the overall returns of these funds, placing pressure on fund managers to deliver higher returns to satisfy the expectations of foreign investors. When foreign investors exit, rupees are converted back into dollars, and long-term rupee depreciation has the potential to reduce dollar IRR (internal rate of return) during repatriation. This situation poses significant challenges for funds that raised commitments in dollars, as they must now demonstrate returns amidst a depreciating rupee.
Expert Insights and Strategies
Shagoofa Khan, an independent consultant, emphasized the importance of managers ensuring higher rupee distributions from investments to account for forex and tax implications. Mature funds currently in exit mode are expected to be the most impacted, as they initially invested when the rupee was stronger. Additionally, funds with substantial dry powder and longer life-cycles, such as infrastructure and real estate funds, may face challenges due to the currency devaluation.
Nandini Pathak, a Partner at Bombay Law Chambers, highlighted that limited partners (LPs) may demand a dollar-based hurdle to transfer currency risk onto the funds. Fund managers could be required to showcase performance in both currencies while offering clear metrics to distinguish exchange rate fluctuations from underlying investment performance. As investment managers launch new funds, they will need to adjust their strategies to align with market demands and investor expectations.
Yashesh Ashar, a Partner at Illume Advisory, suggested various approaches fund managers could take to mitigate the impact of rupee depreciation. These strategies include increasing hurdle rates in dollar terms, calculating returns in rupee terms, encouraging investors to hedge their rupee exposure, and strategically timing portfolio company exits to offset currency fluctuations.
Portfolio Hedging and Global Considerations
While alternative investment funds are generally prohibited from hedging their portfolios, certain funds operating export-oriented portfolio companies may benefit from a natural hedge against rupee depreciation. On the other hand, funds with domestic or import-focused companies may face indirect negative effects at the portfolio level. Diversification and hedging strategies are becoming increasingly crucial, with global investors reconsidering their India allocations and domestic investors exploring overseas investments to diversify their portfolios.
Vivaik Sharma, a Partner at Cyril Amarchand Mangaldas, highlighted the importance of IFSC (International Financial Services Centre) funds in mitigating the impact of rupee depreciation. These funds may be better positioned to weather currency fluctuations and maintain their dry powder. However, setting up a GIFT City feeder may not provide a robust solution in the face of exchange rate fluctuations. Fund managers should explore currency hedging solutions to safeguard their investments against rising exchange rates.
In conclusion, the impact of rupee depreciation on overseas investors in PE funds underscores the need for proactive strategies, clear communication between managers and investors, and a comprehensive understanding of currency risks. As the global economic landscape continues to evolve, fund managers must adapt their approaches to navigate currency fluctuations and protect investor interests.
