Decoding the remarkable growth of CAT III funds

CAT III funds represent a unique class of AIFs, leveraging complex trading strategies that may include long only, long-short, absolute return, and arbitrage. These funds aim to deliver superior absolute returns, making them an attractive option for investors seeking diversification and downside protection. The growth trajectory of CAT III funds has been nothing short of exceptional. In the past year alone, commitments to this category surged by an extraordinary 77%, far outpacing the growth rates of 25% and 21% recorded by Category II and Category I funds, respectively. Notably, investments by CAT III funds have reached an impressive 111% of their raised capital, showcasing their ability to efficiently deploy reserves and optimize market opportunities. Industry projections remain bullish, with commitments to CAT III funds expected to reach approximately INR 2.5 lakh crore by 2028. Such optimism stems from the segment’s innovative approach to investment, bolstered by enabling regulations and increasing investor confidence.

Rise of quantitative strategies

Among the diverse strategies employed by CAT III funds, quantitative (quant) strategies have emerged as a transformative force, redefining the investment landscape. These strategies rely on advanced algorithms, mathematical models, and data analytics to identify market inefficiencies and generate alpha. By eschewing traditional methods often influenced by emotional biases, quant-based funds provide a disciplined, data-driven approach to investing. Globally, quant funds have achieved remarkable dominance, with the top five hedge funds operating on quant-driven methodologies. In 2024, the global quant fund market was valued at approximately USD 16 trillion and is projected to grow at a CAGR of around 10.1% over the next seven years. India, though still in the early stages of adopting this approach, has demonstrated significant potential. Currently, only 1.5% of assets under management (AUM) in India’s investment landscape (including mutual funds, PMS, and AIFs) are managed using quant strategies, compared to 35% in the United States. However, the AUM of Indian quant mutual funds has grown exponentially—from INR 3 billion in 2013 to nearly INR 914 billion in 2024—representing a staggering CAGR of approximately 86% over the past three years.

Why quant funds are gaining traction

Quant-based funds offer several distinct advantages, particularly in today’s volatile and sentiment-driven markets:

Investors are increasingly drawn to quant funds for their ability to provide uncorrelated, complementary sources of returns, making them a valuable addition to diversified portfolios.

A promising future for CAT III funds

As India's investment landscape evolves, CAT III AIFs are emerging as a crucial avenue for high-net-worth investors, offering a blend of innovation, performance, and regulatory support for long-term growth. The depth of CAT III funds in the AIF market is expected to expand as more fund managers embrace entrepreneurship, bringing in diverse and sophisticated strategies that enrich the industry. Additionally, these funds have the largest possible arsenal of investment opportunities available to any pooling vehicle in India. They can deploy capital across multiple asset classes—including cash, equities, fixed income, commodities and FX - both spot and derivatives, listed and unlisted, leveraged or otherwise. This flexibility enables fund managers to create strategies catering to investors’ needs across various spectrums – risk, liquidity, duration, asset class mix. For both investors and fund managers, CAT III funds present abundant opportunities, making them a dynamic and integral part of India’s alternative investment ecosystem.