(Adds more details from letter, information on fund, analyst comment)
By Nishant Kumar
April 23 Macquarie's Asia hedge fund has exited its short positions in Indian single stock futures in response to a controversial set of proposed tax rules that could lower investment returns.
Instead, it has decided to use a futures contract linked to India's 50-share NSE index Nifty on the Singapore Exchange to get its short exposure to India, according to an investor letter of the fund seen by Reuters, a switch other funds may also make.
The $1.5 billion Macquarie Asian Alpha Fund, one of the top performing in Asia and among just the 30 or so hedge funds with $1 billion or more in the region, also cut India long exposure in March, joining a number of foreign investors reducing their holdings in the country ahead of the expected tax rules.
Foreign investors have raised concerns on two recent Indian provisions to tax indirect investments and combat tax evasion.
The first gives India power to retroactively tax the indirect transfer of assets. The second targets tax evaders via the General Anti-Avoidance Rule (GAAR), putting the onus on investors registered in countries with special tax exemptions with India to prove they do not intend to explicitly avoid tax.
The Macquarie fund's India stock short positions dropped from 2.6 percent in February to nil in March, while the gross exposure, or the sum of its long and short positions, fell to 3.2 percent from 5.4 percent, according to the investor letter.
Nick Bird, the Macquarie fund's portfolio manager, told clients in the letter sent last week that the fund could become liable for capital gains tax on unrealised gains after April 1 and open positions in single stock futures, which roll monthly in India, might attract tax.
"We realised gains in long Indian stock positions which had performed strongly since we entered into the positions," Bird told clients, adding the fund also did not roll over single stock futures exposure.
Going long refers to buying and holding a security to sell at a higher price. Taking a short position means selling a security that one does not own, in the hope of repurchasing it at a lower price and profiting from the price differential.
The fund booked profits in Tata Motors, Welspun Corp, Hexaware Technologies and Oil & Natural Gas Corporation, the newsletter showed.
"These changes were unfortunate given we prefer, for risk control reasons, to gain our short exposure via individual stocks rather than index futures contracts," Bird wrote.
"Also, it reduced our gross exposure in India at a time when we were seeking to increase our overall gross exposure."
Bird guided clients to his co-portfolio manager Andrew Alexander for further information. Alexander declined to comment when contacted by Reuters. A spokeswoman for Macquarie could not be reached immediately for comment.
Pranav Sayta, a partner at Ernst & Young in India, said there was still a lack of clarity on GAAR but if the current provisions are implemented as they are one cannot rule out the risk of tax authorities attempting to treat investment gains from India's single stock and index futures as short-term capital gains in which case foreign investors may be asked to pay at least 30 percent tax.
He said the situation was fluid but a move to Nifty futures listed on Singapore Exchange was likely to avoid such tax.
The market-neutral long/short hedge fund from Macquarie Group has tripled assets since the start of 2011.
It generated a return of 9 percent last year when Asia-focused hedge funds, as measured by the Eurekahedge index, lost 8.3 percent. The fund has returned 1.3 percent in 2012 till end-March. (Additional reporting by Rafael Nam in MUMBAI; Editing by Michael Flaherty and Muralikumar Anantharaman)