What Is An Alternative Investment Fund?

  •  6 min
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  • 05 Oct 2023
What Is An Alternative Investment Fund?

Key Highlights

  • An Alternative investment fund is an investment vehicle that collects funds from domestic and international investors and invests the corpus while adhering to a predetermined investment philosophy.
  • AIFs mostly invest in illiquid and unlisted companies like startups, real estate, private equity funds, etc.
  • AIFs fall into one of three categories: category I, category II, or category III AIFs.
  • Individuals must invest a minimum of Rs. 1 crore in an AIF.

Alternative investment funds accumulate capital from knowledgeable private investors. The money raised is invested in line with the AIF's investing philosophy. AIFs are exempt from the mutual funds regulations of the Securities and Exchange Board of India (SEBI). Instead, Regulation 2 (1) (b) of the Regulation Act, 2012 of SEBI applies to AIFs in India. It allows for the establishment of AIFs as companies, limited liability partnerships (LLPs), corporate entities, or even trusts.

AIFs make investments in non-traditional assets. The Securities and Exchange Board of India divides AIFs into three major groups. They are Category I, Category II, and Category III AIFs. Depending on the wide definition of the category, each investment falls under a different category. Private equity, hedge funds, angel funds, and venture capital, are some prime examples.

AIFs have higher entry requirements and costs than traditional investments. Since the asset classes they invest in are quite rare, finding the valuation of AIFs might be challenging. AIFs lack liquidity since only a small number of investors may purchase them. Because the overall turnover of AIFs is less than with typical investments, the transaction costs are lower. AIFs do not disclose any fund-related information to the general public. AIFs also have fewer opportunities to showcase to the investors.

According to the market regulator SEBI, AIFs fall under the following three major categories. They are further subdivided into subcategories, as shown below.

1. Funds In Category 1 AIFs

These alternative investment funds frequently make investments in start-ups, early-stage firms, social enterprises, small and medium-sized organisations, and infrastructure. They may also invest in industries or regions that the government or regulators deem to be desirable from a social or economic standpoint. The government offers tax incentives or other benefits to investors in these types of funds. They include the following.

Funds for venture capital: These funds invest largely in emerging companies with a strong potential for development and a need for capital. These funds must put two-thirds of the surplus funds into the equity shares of these firms in accordance with SEBI regulations. The remaining one-third may be used to purchase debt instruments, unlisted firm initial public offerings (IPOs), equity shares of any financially unsound listed company, etc.

SME Funds: As their name indicates, these funds invest in small and medium-sized businesses. These businesses may be unlisted, listed, or have applied for listing on the SME stock exchange. SEBI regulations require these funds to invest at least 75% of the surplus funds in these businesses.

Social venture funds: These funds make investments in profitable companies that also make a beneficial contribution to society by addressing different environmental and social issues. Affordable healthcare, sustainable energy, financial inclusion, and other topics are some of the themes. These funds must invest at least 75% of assets in them, in accordance with SEBI regulations.

Infrastructure Funds: These funds invest in companies that create infrastructure, such as rail, roads, ports, airports, and power. According to SEBI regulations, at least 75% of these funds' assets must be in unlisted companies. The remaining 25% may be put towards listed debt instruments of businesses engaged in the development, management, and holding of infrastructure projects.

Angel Funds: These funds are a particular subset of venture capital funds that invest in startups or very early-stage enterprises in exchange for an equity share, giving them the necessary resources to grow or develop. However, only angel investors may provide funding for these funds.

2. Funds In Category 2 AIFs

Funds invested in both debt and equity instruments fall under this category. The government does not grant any incentives for investments made for Category 2 AIFS.

Funds for private equity: Private equity funds invest in unlisted private enterprises. It is challenging for privately held enterprises to raise capital through the issuance of equity and debt instruments. The lock-in period for these funds typically lasts 4 to 7 years.

Debt Funds: Debt securities of unlisted companies make up the majority of this fund's holdings. These businesses often adhere to sound corporate governance principles and have significant room for expansion. They are a dangerous alternative for cautious investors because of their poor credit rating.

Funds of Funds: These funds focus on making investments in other alternative investment funds.

3. Funds In Category 3 AIFs

These funds follow advanced trading approaches to invest in listed or unlisted derivatives. The following funds fall within this category:

Private Investment in Public Equity Funds (PIEFs): These funds invest in publicly traded companies by purchasing their stock at a discount.

Hedge funds: They assemble cash from individuals and businesses to participate in the local and international debt and stock markets. To give its investors a better return, these schemes employ an aggressive investing approach.

Here are some of the advantages of investing in AIFs.

  • AIFs' performance is independent of stock market fluctuations, which may assist in lessening the volatility that is sometimes linked to traditional investments.
  • Aids in market diversification and investing style diversity.
  • Strong potential for performance improvement.

The following are the few drawbacks of alternative investment funds.

  • It is necessary to invest a large sum of money, which small-scale investors cannot afford.
  • investment strategy of alternative investment funds is not easily accessible. So, one should be very careful to conduct due research on the funds before investing.

Key Requirements And Guidelines For Investing In AIFs The criteria for investing in alternative investment funds are as follows.

  • Indian residents, Foreigners, and even NRIs can invest in AIFs. The minimum investment threshold for investors is Rs 1 crore. - Directors, staff members, and fund managers must have a minimum annual salary of Rs. 25 lakh.
  • AIFs typically have a three-year lock-in period.
  • Each plan may have up to 100 investors participating.
  • There can be a maximum of 49 investors in an angel fund.


AIFs are an appealing option for investors looking for high returns with a certain amount of risk. They are distinct investment avenues that privately pool funds. There are enough regulatory frameworks for alternative investment funds in india. Less exposure to market volatility and diversification are the key benefits they offer. However, one must have substantial funds to invest in AIFs. Moreover, accessing information regarding their investment plans is a bit difficult. So, before making an AIF investment, investors must fully understand the fund and obtain all the relevant information regarding it.

FAQs On Alternative Investment Funds

AIFs may be a good option for High Net Worth Individuals (HNIs) who seek to diversify their investment portfolio and take advantage of their high return potential. AIFs give investors access to alternative securities with higher returns by investing in securities that are different from traditional investments like equities, bonds, mutual funds, etc.

Any domestic, foreign, or non-resident Indian investor can invest in AIFs if he has the required funds and is willing to buy unlisted and illiquid stocks.

All forms of alternative investment funds in India, except angel funds, require a minimum commitment of Rs. 1 crore. The angel fund will receive Rs. 25 lakh in funding.

Corpus" refers to the total amount of investments that investors make in an AIF as pledged. It is mentioned in a written agreement.

AIFs in Categories I and II are closed-ended and have a minimum term of three years. However, Category III AIFs may have an open-ended. So, you can subscribe to them any time during their lifetime.

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