Inside This Article
Alternative Investment Funds (AIFs) are becoming popular with wealthy individuals and large investors in India. The AIF market reached about ₹6.94 lakh crore by March 2024, growing nearly 30% each year. Investors are drawn to AIFs because they offer the chance for higher returns and more variety than regular stocks or bonds.
This white paper gives an easy overview of AIFs—what they are, the main types, key rules, and how to register one. On the last page, you’ll find a simple guide to help you decide if AIFs fit your investment goals.
What Are Alternative Investment Funds (AIFs)?
An Alternative Investment Fund (AIF) is a private fund that gathers money from rich or experienced investors to invest in things other than regular stocks and bonds. In India, AIFs follow SEBI’s 2012 rules. They play a big role in the market by supporting projects in infrastructure, startups, and struggling companies.
Main Features of AIFs:
- Pooled Investment: Many investors combine their money, which expert fund managers then handle.
- Alternative Assets: AIFs invest in private equity, real estate, hedge funds, and venture capital instead of common investments.
- For HNIs: With a minimum investment of ₹1 crore, AIFs are mainly for high-net-worth individuals, family offices, and big investors.
Types of Alternative Investment Funds
AIFs have been categorized into three, which cater to different types of investors and regulatory regimes.
Category I AIFs
These types of funds invest in social or economic activities such as start-ups, infrastructure, and SMEs. Category I AIFs are often exempted from certain regulations as they contribute to the country’s economic development.
Some of the Key Types
- Venture Capital Funds: This type of fund mainly focuses on early-stage businesses that have a high potential for growth.
- Infrastructure Funds: This segment would include the infrastructure developing projects of roads, bridges, power plants, etc.
- Social Venture Funds: These would raise financial returns in addition to some social returns.
Know More: Category I AIFs: The Growth Engine Of Significant Investments
Category II AIFs
Category II AIF is not exposed to any of the preferential or special privileges/controls of SEBI. Chiefly these consider the instruments of equity and debt.
Major ones are:
- Private Equity Funds: These funds invest in companies that are not listed on the stock market. They often take a large or controlling stake, allowing them to guide major business decisions and help the company grow.
- Debt Funds: These funds invest in debt instruments such as corporate bonds, debentures, and other structured debt products. Their goal is to earn steady returns through interest income while managing risk carefully.
Learn More: Category II AIFs: Flexible Yet Regulated Investments
Category III AIFs
These funds are using sophisticated strategies which include leverage and derivatives. Most of the funds fall in the category of hedge funds.
Key Features:
- Short-Term Orientation: It is using the strategy of short-term gain through trading in derivatives and arbitrage.
- High-Risk, High-Return: These funds are meant for investors with a high risk appetite.
Know More: Category III AIFs: Exploring Complex Strategies
Growth of AIFs in India
According to reports from SEBI, the AIF sector in India has grown in leaps and bounds. Total commitment rose from ₹2.05 lakh crore in March 2019 to over ₹6.94 lakh crore in March 2024. The demand for diverse investment instruments beyond traditional vehicles like mutual funds and equity stocks seems to be building up.
- Startups & Venture Capital: Category I AIFs have emerged as a crucial source of funds for the Indian startup ecosystem, and more than ₹35,000 crore was raised through venture capital funds alone in 2023.
- Infrastructure Development: Category I infrastructure funds are gaining pace with large-scale infrastructure projects in the foreground due to government initiatives.
Regulatory Framework for AIFs
SEBI governs AIFs so that investors would not suffer, and it would keep the market stable and transparent at its best. SEBI (Alternative Investment Funds) Regulations, 2012 elaborates with guidelines regarding fund managers and investors with regard to this kind of investment. The key requirements set by these regulations include the following,
- AIF Registration: In order to work, an AIF needs to get registered before SEBI.
- Minimum Corpus: To become operational AIF must hold a corpus of Rs 20 crore.
- Investment Restrictions: For instance, Category I and II AIFs cannot invest more than 25% of their corpus in one entity, thereby diversifying the portfolio.
- Limits on Leverage: Category III AIFs may use leverage, though SEBI has prescribed certain limits.
Benefits of Investing in AIFs
AIFs offer numerous advantages, especially for the savvy investor who wants to have access to various classes of assets and strategies.
- Diversification: AIFs enable investors to diversify in asset classes like real estate, private equity, and startups which are otherwise unavailable through traditional funds.
- Potential for High Returns: The AIF managers focus on sectors with high growth prospects, such as venture capital or distressed assets, which can yield outsized returns.
- Professional Management: Being managed by professionals who are experienced in alternative investments reduces risks since it will be channelled strategically.
Risks of AIFs
Although they provide luscious opportunities, AIFs involve certain risks:
- Illiquidity: The lock-in period of an AIF is usually longer, even up to 7-10 years.
- Higher Risk: This moves to a higher risk level since the investments are, in fact, startups or distressed assets. AIFs are therefore much more dangerous than the traditional ones such as mutual funds.
- Regulatory Risk: An amendment in SEBI rules can have an immediate and direct effect on the performance of the AIF and, consequently, on the returns on investment.
How to Register an AIF in India
SEBI has a clear process for registering an Alternative Investment Fund (AIF). Here’s how it works:
- Set Up the Fund: The fund must be created as a company, LLP, or trust.
- Submit the Application: The AIF applies to SEBI with all required documents, including details about the sponsor, manager, and trustee.
- Get Approval: After SEBI reviews and approves the application, the fund is added to SEBI’s AIF database and can start operating.
- Stay Compliant: The AIF must follow SEBI’s rules and regularly submit reports and disclosures to stay compliant.
Pro Tip: NBFC Advisory offers services that make AIF registration and compliance simple, helping your fund remain SEBI-compliant at all times.
Who should invest into AIFs?
AIFs are designed for sophisticated investors who understand the play of risk and reward. Normally, AIF investors include:
- High-Net-Worth Individuals (HNIs)
- Institutional Investors
- Family Offices
- Corporate Entities
How to Choose the Right AIF
When choosing an AIF, ensure that the investment strategy of the fund matches your financial goals and risk tolerance. Here’s how you can evaluate your options:
- Set Your Investment Objectives: Do you want short-term returns, long-term wealth building, or diversification?
- Risk Assessment: Determine the risk level of each AIF category and ensure it is in line with your risk tolerance.
- Track Record of Fund Manager: Always look at the performance history and credibility of the fund manager before making a decision.
Conclusion
Alternative Investment Funds (AIFs) are an exciting option for experienced investors who want to grow their money beyond regular stocks and bonds. They invest in areas like startups, real estate, and struggling companies. These can offer high returns, but they also come with higher risks. Knowing the categories, frameworks, and registration process will help effectively navigate this space.
If you ever plan to set up an AIF or invest into one, NBFC Advisory will help you through this process from registration of the AIF till compliance. Now, let’s get moving towards smarter and diversified investments today!
Do you have questions about AIF registration or AIF regulations? Please leave your comment below, and we’ll be glad to assist! If you found this guide helpful, share it with your network. For more expert advice on setting up or managing AIFs, contact NBFC Advisory today.
