Alternative Investment Funds (AIF): Why and What Should You Know?

₹8.3 trillion! That's the aggregate raised amount by over 1,000 registered Alternative Investment Funds (AIFs) in India, as reported by the Securities and Exchange Board of India (SEBI) data as of March 2023!

This significant growth underscores investors' increasing preference for AIFs over conventional options like mutual funds, stocks, cash, or bonds. 

These investment vehicles offer access to alternative asset classes and present the potential for higher returns compared to traditional investments. 

Let's begin by figuring out what exactly an AIF is.

What is an Alternative Investment Fund?

AIF represents private pooled investment funds specialising in alternative asset classes, including hedge funds, private equity, venture capital, real estate, commodities, and other non-traditional investment types.

In contrast to traditional investments, AIFs operate independently of SEBI (Mutual Funds) Regulations, 1996, or any other regulations overseeing fund management activities. Instead, they adhere to the SEBI (Alternative Investment Funds) Regulations, 2012.

AIFs present opportunities for diversification, promising higher returns and access to asset classes not readily available through traditional investments. 

Typically favoured by seasoned investors comfortable with higher risks for potentially greater rewards, these funds primarily attract High Net Worth Individuals (HNIs) and institutions due to the generally higher minimum investment compared to traditional avenues.

Around 1,148 cumulative alternative investment funds were registered across India as of the fiscal year 2023, which is a significant increase compared to the previous year.

Types of AIFs in India

In India, AIFs are put into three big groups based on how they invest and what they aim to do, as decided by SEBI.

Category I AIF 

This category includes AIFs primarily investing in start-ups, early-stage ventures, social ventures, SMEs, or infrastructure projects. 

Category I AIFs play a crucial role in fostering entrepreneurship and supporting the growth of innovative businesses in India.

Category II AIF

AIFs in this category invest in mid-stage or late-stage businesses' unlisted or private space. They can be in the form of equity or debt funds. 

Private equity funds, real estate funds, debt funds, and funds for distressed assets are examples of Category II AIFs. 

These funds provide capital to businesses at various stages of their growth and help unlock their potential.

Category III AIF

This category includes AIFs that primarily invest in the listed space of equities across large, mid, and small-cap businesses. Category III AIFs can employ diverse or complex trading strategies and may use leverage through investment in listed or unlisted derivatives. 

Hedge funds, PIPE (Private Investment in Public Equity) funds, and long-short funds are examples of Category III AIFs. 

These funds offer investors opportunities to generate returns by actively managing their portfolios and capitalising on market inefficiencies.

Explore the data about what Alternative Investment Funds are up to below.

Who Can Invest in an AIF?

AIFs in India are open for investment by Indian residents, non-resident Indians (NRIs), and foreign nationals. However, the minimum investment requirements vary depending on the category of the AIF:

1. The minimum investment limit in most AIFs is ₹1 crore for investors.
2. Employees, directors, and fund managers of the AIF or the fund manager have a minimum investment limit of ₹25 lakh.
3. Joint investors, such as spouses, parents, or children of investors, are also allowed to invest in AIFs.
4. The maximum number of investors per scheme is limited to 1,000. It is important to note that the minimum investment amount in angel funds is lower, with a minimum corpus of ₹10 crore and a maximum of 49 investors per scheme.
5. It is important to note that AIFs must be registered with SEBI under the SEBI (Alternative Investment Fund) Regulations, 2012, to offer investment opportunities to the public.

Benefits of Investing in AIFs

Investing in AIFs offers several benefits to investors, including:

Portfolio Diversification

AIFs provide exposure to non-traditional assets such as start-ups, private equity, real estate, and hedge funds. Investing in these alternative asset classes can help diversify investment portfolios and reduce overall portfolio risk.

Potential for Higher Returns

AIFs have the potential to offer higher returns compared to traditional investments. For example, venture capital funds have generated an average yearly return of around 20%, while stock markets and mutual funds have generated average annual returns of 9.2% and 10%, respectively.

Limited Investor Liability

Investors in AIFs typically have limited liability, which means they are only responsible for the amount they have invested in the fund. They are not liable for losses beyond their investment amount.

Access to Unique Investment Opportunities

AIFs provide access to asset classes and investment strategies that are not easily accessible through traditional investments. This allows investors to participate in the growth of innovative start-ups, real estate projects, and other alternative investments.

What is the Difference Between Mutual Funds and AIFs?

While both mutual funds and AIFs are investment vehicles, there are key differences between the two:

The Bottom Line

With different categories catering to various investment strategies and objectives, AIFs offer flexibility and tailored investment options for high-net-worth Individuals, family offices, and institutional investors.

However, it is essential for investors to carefully evaluate the risks associated with investing in AIFs, such as limited liquidity, higher fees, and potential regulatory concerns. 

Consulting with a financial advisor and conducting thorough research is crucial before making any investment decisions.

As the AIF industry continues to grow and evolve, it is expected to become more accessible to midsize retail investors in the future.