A guide to Alternative Investment Funds (AIFs)

Alternative Investment Funds (AIFs) are a new type of investment instrument that has evolved in a world where traditional assets like equities and bonds prevail. However, exactly what is an alternative investment fund​?

Investors can use AIFs to invest in several possibilities, including start-ups, private companies, and real estate. Knowing what alternative investment funds are can lead to interesting opportunities for people looking into fresh options for increasing their wealth.

Let’s explore AIFs, their different types, and the reasons why certain Indian investors may consider them a wise option.

What is Alternative Investment Fund?

An alternative investment fund, or AIF, is a type of investment that does not follow the footsteps of more conventional and well-known options like equities, bonds, and mutual funds. This privately pooled investment instrument invests in derivatives, goods, real estate, hedge funds, private equity, and venture capital, among other alternative asset classes.

Alternative Investment Funds can be set up as a Limited Liability Partnership (LLP) or a company, and they may invest in equity shares of unlisted businesses. SEBI guidelines govern them, and funds that are subject to the 1996 and 1999 SEBI laws, as well as any other Board laws governing fund management operations, are excluded.

September 2024 saw investment commitments topping ₹12,43,083 for the first time, while the funds raised were ₹5,01,503. The amount of money generated and pledges made to AIFs has increased by about 30% annually as wealthy people have embraced the investment vehicle in pursuit of higher returns.

Features of AIF

The unique characteristics of alternative investment funds set them apart from conventional investments. Although AIFs frequently carry greater risk, they can also yield greater returns. The following features can help understand what is alternative investment fund better.

1. Regulation

An AIF must be registered under SEBI regulations. SEBI establishes the rules and regulations for AIFs, including eligibility requirements, limitations on investments, disclosures, and reporting duties.

2. Investment Methods

AIFs provide a broad range of investing methods beyond conventional asset classes. They have access to several alternative investment options, including debt, equity, infrastructure, real estate, hedge funds, and venture capital. AIFs may accommodate different investor tastes and risk tolerances because of their adaptability.

3. Risk and Returns

It usually works to produce superior returns by focusing on higher-risk investments. An AIF’s asset allocation and investment strategy determine its risk profile. However, the investors should carefully weigh the risk-return tradeoff and match it to their risk tolerance and investing goals.

4. Lock-in Period

There may be a lock-in period for AIFs, during which time investors are unable to withdraw their money. The investment strategy, liquidity needs, and exit provisions of the fund define the lock-in time, which varies based on the AIF category.

Types of AIFs

According to the SEBI, AIFs are divided into the following three groups. By being aware of these categories, investors can select the best AIF that fits their risk tolerance and investing objectives.

1. Category I AIFs

Category I AIFs include infrastructure funds, venture capital funds, social venture funds, SME funds, and any other alternative investment funds that may be specified. These funds concentrate on economic-friendly investments. The objective is to give investors rewards while promoting innovation and economic growth.

Investment options included in this category are:

• Angel Funds
• Start-Ups
• Small And Medium Enterprises Fund
• Early-Stage Ventures
• Social Venture Funds
• Venture Capital Funds
• Social Impact Funds
• Special Situation Funds
• Infrastructure Funds
• Other AIFs, as specified by SEBI

2. Category II AIFs

This category includes funds for which the government or authorities do not specifically offer incentives or concessions. Investment in this category avoids using leverage or borrowing for purposes other than meeting daily operational needs. It strives to give its investors good returns while taking on moderate risk.

Investment options included in this category are:

• Debt Funds
• Private Equity Funds 
• Fund of Funds
• Other funds that are not classified as Category I or Category III

3. Category III AIFs

Category III AIFs are the most dangerous and most speculative funds. These funds employ sophisticated techniques like high-frequency trading, short selling, and hedging to produce returns. 

These funds have the potential to generate large returns, but they are also more erratic and may result in larger losses. Investors in Category III AIFs should have a higher risk tolerance and be ready for market swings. 

Investment options included in this category are:

• Private Investment in Public Equity Fund (PIPE)
• Hedge Fund

Who Can Invest in Alternative Investment Funds?

It’s not as easy to invest in AIFs as it is to purchase business stock. There are requirements investors must fulfil in order to invest in AIFs in India. The following are the eligibility criteria for investing:

• The applicant must be an Indian, foreign national or Non-Resident Indian (NRI).
• All schemes are limited to a maximum of 1,000 investors, whereas angel funds have a cap of 49.
• Investors are required to invest a minimum of ₹1 crore. This cap is ₹25 lakh for fund managers, directors, and staff.
• The majority of AIFs have a three-year minimum lock-in duration. 
• AIF is also available to joint investors. They may be an investor’s spouse, parent, or child. 

Taxation of AIFs

The taxation of AIFs is contingent upon the type of AIF category in which you have invested.

Categories I and II of AIFs have been given a pass-through status. This indicates that all money received by the AIF is exempt from taxes, with the exception of business revenue.

No pass-through status has been granted to Category III. This implies that the fund will have to pay taxes on the income received. Taxation, however, differs according to the fund type. Investors in this category are exempt from paying taxes on their gains.

To Sum Up

With the help of alternative investment funds (AIFs), investors can investigate fresh, possibly lucrative options outside the realm of traditional investments.

Although they are risky, AIFs also provide the potential for increased diversity and higher returns. As they continue to expand in India’s financial ecosystem, they are growing in importance.

Anyone interested in learning more about AIFs should understand the different types, dangers, and rewards before making an investment. With the correct information and direction, AIFs can be a useful addition to a portfolio. Happy investing!