What is an Alternative Investment Fund?

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  • 18 Dec 2023
What is an Alternative Investment Fund?

Key Highlights

  • In alternative investment funds, private pooled funds are invested in hedge funds, private equity, venture capital, and other instruments.
  • SEBI categorises AIFs into three categories, each serving distinct investment purposes.
  • AIFs offer benefits such as high return potential, low volatility, and diversification.

SEBI has categorised Alternative Investment Funds into the following 3 categories:

Funds under category 1 invest in SMEs (small and medium-sized enterprises), start-ups, and new economically viable businesses with potential for high growth.

1. Venture Capital Fund (VCF) Venture capital funds can be approached by new entrepreneurial firms that require significant financing during the initial days. This kind of fund invests in start-ups that have the potential for high growth. HNIs investing in VCF adopt a high risk and high-return strategy while allocating their resources.

2. Angel Funds Investors invest in budding start-ups and are called angel investors. In addition, investors bring early business management experience with them. These funds invest in those start-ups that do not receive funding from venture capital funds. Each angel investor needs to invest a minimum of Rs. 25 lakh.

3. Infrastructure Funds This fund puts money into companies that work on projects like building railways or ports, which are part of infrastructure development. Funds are invested in these projects by investors who believe they will succeed.

4. Social Venture Funds These funds invest in a socially responsible business. They are a kind of philanthropic investment. However, they have a scope of generating decent returns for investors.

These funds do not use leverage other than to cover operational needs and do not fall under categories 1 and 3. Below are the funds under Category 2:

1. Debt funds These funds invest in debt securities of companies that are unlisted. The fund thinks these companies follow good governance practices and have the potential to grow.

2. Funds of funds These funds invest in various other Alternative Investment Funds (AIFs). They don't have their own investment portfolio; instead, their primary focus is on investing in different AIFs.

3. Private equity fund Private equity funds invest in businesses that are unlisted and struggle to raise money through loans or selling shares.

Category 3

These funds engage in many complex trading techniques. Below are the funds under Category 3:

1. Private Investment in Public Equity Fund (PIPE) A PIPE invests in the stocks of companies that are publicly traded. They buy these stocks at a discounted price. Choosing PIPE investments is more convenient than opting for a secondary issue because it involves less paperwork and administrative work.

2. Hedge Funds Hedge funds pool money from accredited investors and institutions. They invest in both domestic and international debt and equity markets. Hedge funds adopt an aggressive investment strategy to generate returns.

Investors looking to broaden their investment portfolio can consider AIFs if they satisfy the following eligibility conditions:

  • Residents of India, NRIs, and foreign nationals are eligible to invest in these funds.
  • The minimum investment amount is Rs. 1 crore for regular investors, while directors, employees, and fund managers have a minimum investment requirement of Rs. 25 lakh.
  • AIFs have a mandatory minimum lock-in period of three years.
  • The number of investors in each scheme is limited to 1000, with the exception of angel funds, where the maximum number of investors is set at 49.

AIFs offer the following benefits:

1. High Return Potential AIFs typically offer more potential for returns compared to other investment choices. The substantial pool of funds provides fund managers with ample flexibility to devise strategies aimed at maximising returns.

2. Low Volatility AIFs do not have a direct link to stock markets. Their volatility tends to be lower, especially when compared to conventional equity investments. This makes them a potentially suitable option for investors who are cautious about risks and seek stability.

3. Diversification AIF allows much-needed diversification in an investment portfolio. They act as a cushion at the time of market volatility or financial crisis.

Conclusion

AIFs offer an attractive choice for investors aiming for substantial returns with a reasonable level of risk. Prior to investing in AIFs, it's crucial for investors to comprehend the fund and its associated risks thoroughly. AIFs have become a noteworthy investment option, particularly for high-net-worth individuals seeking high returns while being cautious about taking on significant risks. Investors have the opportunity to engage in comprehensive market research and select a specific category of AIF that aligns with their financial goals and risk tolerance.

FAQs on Alternative Investment Fund

An Alternative Investment Fund (AIF) is defined as any fund formed or registered in India, functioning as a privately pooled investment vehicle. It gathers funds from investors with the purpose of investing according to a specified investment policy, ultimately benefiting its investors.

Investors are required to invest a minimum of Rs. 1 crore, while directors, employees, and fund managers have a minimum investment amount of Rs. 25 lakh.

The SEBI (Securities and Exchange Board of India) regulates AIF.

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