The alternative investment fund is a unique investment vehicle that is beyond traditional investments like fixed deposits, equity, mutual funds, stocks, etc. Rightly named, alternate investment funds act as an alternative investment option to conventional ones. These investments are well suited for mature investors, who are willing to take higher risks to earn higher returns.
As per the recent data by SEBI, it has shown an overall growth of 30% in FY 2022-23. As of March 2022, the total commitment raised was Rs 6.41 lakh crore; in March 2023, it increased to Rs 8.34 lakh crore. In this article, we will understand alternative investment funds, their types, and their benefits. Along with this, we will explore the details of taxation and the reasons you should invest in AIFs.
What is an Alternative Investment Fund?
Alternative Investment Fund or AIF is not a conventional investment vehicle rather a privately pooled investment fund that invests in alternative asset classes such as private equity, venture capital, hedge funds, real estate, commodities, and derivatives. This fund is more popular among the HNIs (High net worth individuals) and mature institutions as the investment amount is substantially higher.
Despite being a privately pooled investment vehicle, AIFs are regulated and governed by the SEBI (Securities and Exchange Board of India). As per the SEBI (Alternative Investment Funds) Regulations, 2012, an AIF can be set up as a trust, a company, a limited liability partnership, or a corporate body. However, many of the AIFs that have been registered with SEBI are in the form of trusts.
Types of AIFs in India
- Category I AIF
- Category II AIF
- Category III AIF
Based on the investment groups and strategies, AIFs are divided into different types. AIFs can be further divided into three categories, which are mentioned below:-
Category I AIF:
This category of AIF invests in ventures such as start-ups, early-stage ventures, social ventures, SMEs, or infrastructure or other sectors which have higher growth potential. These investments are considered socially and economically beneficial by the government or regulators. It may be further classified into:
Venture capital funds (Including Angel Funds):
This fund specifically invests in start-up or early-stage ventures that have high growth potential. Early stage entrepreneurial firms which needs high initial funding can approach VCFs.
SME Funds:
This type of fund is the one which specifically invests in small and medium enterprises (SME) with a good track record in profitability and growth.
Social Venture Funds:
Social Ventures or Social entreprises are the companies that aims to make a positive and constructive impact in the society or the environment, such as sustainability, clean energy, etc. Social Venture Funds invest in these social entreprises to support these positive operations.
Infrastructure funds:
Another category I fund is infrastructure funds. This fund primarily aims to fund the infrastructure projects such as railways, bridges, airports, etc.
Category II AIF:
All those AIFs that do not fall under categories I and III are part of category II AIFs. They do not use leverage or borrowing except for the
essential operational expenses to meet their day-to-day working. Some of the funds included in the Category II are as follows:
- Private Equity Funds: It makes equity investments in unlisted companies and helps them to raise capital. As unlisted companies face problems in raising capital through debt or equity, private equity funds allow them to raise capital easily.
- Debt Funds: As the name suggests, this fund invests in the debt securities of the unlisted companies via debt instruments such as bonds, debentures, and other fixed-income instruments.
- Fund of Funds: This fund invests in multiple AIFs. It doesn’t directly buy stocks or bonds. Instead, it invests in a portfolio of other investment funds. A fund of funds, also referred to as a multi-manager investment, gives small investors broad diversification to hopefully protect their investments from severe losses caused by uncontrollable factors such as inflation and counterparty default.
Category III AIF:
These AIFs use complex trading strategies in their investment. It may use leverage or debt for investment in listed or unlisted derivatives. Some of the funds included in Category III are:
Private Investment in Public Equity Fund (PIPE): This fund invests in the equity of companies that are listed on the stock exchange. This often happens when the value of the company’s shares has dropped, and the company is looking to raise capital. Hence, in this case, AIFs receive the equity at a discounted price.
Hedge fund: Hedge fund uses various investment strategies like short selling, arbitrage, futures, derivatives, and margin trading to generate maximum returns for the investor.
Who can invest in an AIF?
After knowing the meaning and types of AIFs, let’s know who can invest in alternate investment fund. The following are the criteria for investing in AIF:
- All Indian Residents
- NRIs (Non-Resident of India)
- Foreign nationals especially, Foreign Portfolio Investors (FPIs) and Qualified Foreign Investors (QFIs)
- Joint investors which can be spouse, parents, or children of investors.
Minimum Amount: The minimum investment amount for investors is Rs1 crore for investors. For directors, employees, and fund managers, this limit is Rs 25 lakh.
Lock-in Period: Most AIFs come with a minimum lock-in period of three years.
Maximum Investors: The maximum number of investors in every scheme is capped at 1,000. However, in the case of angel fund, the cap is 49.
Benefits of investing in AIFs AIFs can be an attractive option for some investors seeking diversification and potentially higher returns outside traditional asset classes like stocks and bonds. Here are some reasons why investors might consider investing in AIFs:
Potential for Higher Returns: AIFs may offer higher returns than traditional investments due to their exposure to a broader range of assets and investment strategies. However, this higher return also comes with higher risk.
Portfolio Diversification: By giving investors access to alternative asset classes, including hedge funds, real estate, and private equity, AIFs help them diversify their
portfolios.
Low Volatility: AIFs invest across asset classes and, are less volatile than Direct equity.
Alternative Investment Fund (AIF) Taxation
Understanding the taxation process, exemptions and status is the most important information to know before investing your money in that fund. It should be noted that AIF taxation depends on the type of the category of AIFs you have invested in. Let’s understand how different categories of AIFs are taxed:
Category I and Category II investments have been given a pass-through status. This means any income (Other than business income) earned by the AIF is tax-exempted.
These gains will be taxable in the hands of investors. It will be taxed as if you have personally made the investments, even though the AIF is the one actually making the investments.
Category III has not been given a pass-through status. This means that the income earned will be taxable in the hands of the fund. However, taxation varies depending on the type of the fund (Company, LLP, trust, etc.). In this category, investors are not required to pay any taxes on the gains.
Conclusion
In conclusion, AIFs can be a good option for diversification, but only mature investors should go for them as they are complex products. It allows them to diversify their portfolios and access exclusive investing techniques through Alternative Investing Funds.
However, investing in AIFs may not be an ideal option for small investors who want to invest a small amount regularly, as investing in AIFs requires a big chunk of corpus. Hence, AIFs are generally considered
suitable for individuals with huge corpus, like HNIs (High net worth individuals), who are willing to take a higher risk and can invest a substantial corpus in one go.
Despite the possibility of greater returns, it is important to carefully weigh the risks and conduct extensive due research before investing.
FAQs
- What is the full form of AIFs?
AIFs stand for Alternate Investment Funds. - What is HNI and Ultra HNI?
HNI stands for High Net-worth Individual. HNIs in India are the individuals with liquid assets exceeding 5 crores. Those with liquid assets exceeding 25 crores are categorised as ultra HNIs. - What is the minimum size of AIF?
The minimum investment limit is Rs 1 crore for investors. For directors, employees, and fund managers, the minimum limit is Rs 25 lakh. - What is the corpus of the AIF?
Corpus is the total amount of funds committed by investors to the AIF by way of a written contract or any such document as on a particular date. - Who is the Sponsor of the AIF?
‘’Sponsor’’ is any person(s) who set up the AIF and includes promoter in case of a company and designated partner in case of a limited liability partnership.
