All you need to know about Alternative Investment Funds

The investment objectives of institutions and high net worth individuals (HNWIs) differ significantly from those of small investors. Alternative Investment Funds provide an opportunity to such investors to expand the scope of their investments beyond traditional avenues like equity, debt, real estate, etc.

This article discusses what AIFs are, their types, potential benefits and who can invest in them.

• Table of contents

• What are alternative investment funds?
• Types of AIFs in India
• Who can invest in an AIF?
• Benefits of investing in AIFs
• Alternative Investment Fund (AIF) Taxation
• Tenure and listing of alternative investment funds (AIF)
• Key Takeaways

What are alternative investment funds?

Alternative Investment Funds are privately pooled investment instruments that focus on non-traditional vehicles such as venture capital, private equity, hedge funds, commodities, derivatives, etc. The Securities and Exchange Board of India (SEBI) mandates that AIFs can be constituted as a trust, a company, a limited liability company, or a corporate body. Thus, AIFs are tailored to suit the unique needs of sophisticated investors like high-net-worth individuals, family offices, and institutional investors who are willing to take higher risks for potentially higher returns.

Types of AIFs in India

Category I AIF:

• Venture capital funds: Invest in high-growth potential start-ups.
• SME funds: Focus on small and medium-sized enterprises with expected growth potential and profitability.
• Social venture funds: Support social enterprises aiming to create positive societal or environmental impacts while generating financial returns.
• Infrastructure funds: Invest in infrastructure projects like highways, airports, and power plants.

Category II AIF:

• Real estate funds: Invest in properties, earning returns through rental income, capital appreciation, or both.
• Private equity funds: Provide growth capital to private companies.
• Debt funds: Focus on fixed-income instruments such as bonds and debentures.

Category III AIF:

• Hedge funds: Use strategies like short selling and leverage.
• Commodity funds: Invest in physical commodities (gold, silver, oil) or related futures and options.
• Private investment in public equity (PIPE): Purchase shares of public companies at discounted rates, offering small to medium-sized companies easy access to funding.

Who can invest in an AIF?

Qualified institutional buyers (QIBs)

QIBs are institutional investors recognised for their financial expertise and resources to invest in AIFs. Examples include banks, mutual funds, insurance companies, and foreign portfolio investors. Their deep market understanding makes them suitable participants in AIFs.

High net worth individuals (HNWIs)

HNWIs are individuals who can invest in AIFs either individually or through investment entities like family trusts. This category of investors often seeks to diversify their portfolios with high-return opportunities.

Family offices

Family offices are specialised entities that manage the wealth of high-net-worth families. Acting on behalf of their clients, these offices can invest in AIFs to ensure tailored wealth management and long-term growth potential.

Employees and directors of the AIF

Employees and directors of the specific AIF category, along with their immediate family members, are eligible to invest in the fund. This provision fosters confidence among external investors as it demonstrates internal stakeholders’ commitment to the fund’s success.

Benefits of investing in AIFs

Portfolio diversification

AIFs invest across a wide range of assets, including real estate, private equity, commodities, and distressed assets. The diversification helps investors mitigate exposure to market volatility and balance the risk profile across their portfolios.

Potential for high returns

AIFs typically target high-risk, high-reward investment opportunities, offering the potential for superior returns compared to traditional investments like stocks and bonds. This makes them a suitable choice for experienced investors seeking higher yields.

Access to specialised opportunities

AIFs provide access to unique to investment opportunities that are often unavailable to retail investors. For instance, funds focusing on start-ups and early-stage companies can enable investors to support innovative ideas and disruptive technologies while benefiting from their growth potential.

Inflation hedge

Certain AIFs invest in assets such as real estate and commodities, which have historically performed well during inflationary periods. This makes them a suitable tool for preserving the value of investments and cushioning against the erosive impact of inflation.

Alternative Investment Fund (AIF) Taxation

Each AIF category differs in its investment approach and, therefore, is subject to different taxation rules. It is crucial for investors to understand the income tax implications of AIF investments.

For Category I and II AIFs, income (excluding business income) is taxed directly in the hands of the investor at their applicable tax rates.

However, for Category III AIFs, the income is tax-free for the investor, as these funds do not have a “pass-through” status. Thus, the onus of paying taxes rests with the fund itself.

Tenure and listing of alternative investment funds (AIF)

Tenure for category I and II AIFs

AIF schemes under Category I and II must be close-ended, with the tenure specified at the time of application. These funds require a minimum tenure of three years.

Flexibility for category III AIFs

Category III AIFs can either be open-ended or close-ended, offering flexibility to suit varying investment strategies and objectives.

Extension of close-ended AIFs

The tenure of close-ended AIFs can be extended by up to two years, provided two-thirds of the unit holders, based on the value of their investments, grant approval. If such consent is not obtained, the fund must fully liquidate within one year after the original or extended tenure expires.

Listing on stock exchanges

Units of close-ended AIFs may be listed on a stock exchange, subject to a minimum tradable lot of Rs. 1 crore. Listing is permitted only after the final close of the fund or scheme and is entirely voluntary, providing fund managers with the option to offer liquidity to investors through trading.

Key Takeaways

• AIFs cater primarily to HNWIs and institutional investors due to high entry barriers like AIF minimum investment requirements.
• With professional management and a focus on high-growth sectors, AIFs present an opportunity to tap alternative investments and potential for wealth creation.
• AIFs can be suitable for high-risk appetite investors aiming to diversify their portfolios with a balanced approach to risk and return.
• Sophisticated and experienced investors with a deep understanding of financial markets and complex instruments can consider AIFs.

Conclusion

Alternative Investment Funds (AIFs) are designed for experienced investors seeking opportunities beyond traditional options like stocks or bonds. Understanding the different types of AIFs and their benefits can help you decide if they match your financial goals. However, it’s important to consult a financial advisor before investing to ensure AIFs fit well with your overall investment plan.

FAQs:

How to invest in alternative investment funds in India?

To invest in AIFs, assess your financial goals, risk tolerance, and timeline. Research thoroughly on strategies, performance, and fees. Consult experienced advisors or firms for guidance. Choose SEBI-registered AIFs for transparency and regulation, ensuring your investment aligns with your overall financial plan.

How to start an alternative investment fund?

To start an AIF, register the fund with SEBI under the desired category. Develop a fund strategy, raise capital from eligible investors, and comply with regulatory requirements, including the fund’s structure and disclosure norms.

How is AIF different from mutual funds?

While mutual funds pool money for diversified investment in securities, AIFs focus on alternative assets like private equity and hedge funds. Additionally, AIFs cater to HNWIs with a higher minimum investment requirement and involve higher risk compared to traditional mutual funds.

What is the difference between PMS and AIF?

Portfolio Management Services (PMS) provide personalised investment management for individual portfolios, whereas AIFs pool funds from multiple investors for collective investments. PMS typically has lower entry barriers compared to AIFs.

What is an alternative investment fund (AIF)?

An AIF is a privately pooled investment vehicle regulated by Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, offering diversified investment opportunities in alternative asset classes such as private equity, venture capital, and real estate, aimed at high-net-worth individuals and institutions.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.