Alternative Investment Funds (AIFs): Meaning, Types and Minimum Investment

Alternative Investment Funds are becoming extremely popular amongst high-net-worth individuals as they have delivered massive returns in 2024. AIFs work like mutual funds that collect money from several investors but they invest in private equity, real estate, etc. AIFs are tailor-made for accredited investors and privately pool the money from investors. In this blog, we’ll deep dive into the meaning of AIF funds, their types, minimum investment amount and benefits of investing in it.

What is AIF?

An AIF fund is a privately pooled instrument that collects money from institutional investors, HNIs, and family offices from India or abroad. The minimum investment amount of AIF is set at ₹1 crore making it accessible to sophisticated investors who are generally high-risk takers. For seamless investing, all the AIF units can only be held by investors in the Demat account effective from October 1, 2024.

The AIF full form (Alternative Investment Funds) clearly defines its meaning as they invest in alternative investment options that are typically difficult to find such as venture capital funds, hedge funds, private equity funds, etc. They are bound by high risk, low liquidity, and high cost, making them suitable only for accredited investors.

Alternative Investment Funds: 3 AIF Categories

AIF come under the SEBI (Alternative Investment Funds) Regulations, 2012 which have divided them into 3 categories based on investment strategy:

1. Category I AIFs

The category I AIF invests in start-ups, SME businesses, infrastructure, and sectors that are considered socially or economically focused.

• Venture Capital Funds: These alternative investment funds invest in new-age startups and small and medium enterprises (SME) having strong return potential but come at a very high risk. These funds help the investors access the early-stage growth companies along with new and growing sectors.
• Angel Funds: Angel funds are types of venture capital funds and raise funds from angel investors. These funds raise money in a private manner through units with a minimum investment amount of ₹25 lakhs.
• SME Funds: Small and Medium Enterprises (SME) funds invest in the private equity of small and mid-size businesses with high growth prospects and innovative business models.
• Social Venture Funds: These AIF funds invest in the equity of companies focused on social initiatives such as healthcare, education, and clean energy.
• Infrastructure Funds: These funds invest in tangible assets such as developing or holding infrastructure projects, energy projects, agriculture assets, or projects. These funds help investors access the high-growth sectors that contribute to the overall economic growth.
• Corporate Debt Market Development Fund: CDMDF buys investment-grade corporate debt securities and provides a boost to the corporate debt market and enhances liquidity in times of market stress.

2. Category II AIFs

The category II AIF excludes the list of funds that come under Category I and III. These funds do not take leverage or borrowing except for meeting regular operating expenses.

• Real Estate Funds: The real estate funds invest in residential or commercial properties and developmental projects.
• Private Equity Funds: These types of alternative investment funds invest in unlisted private companies and hold the potential to earn high returns.
• Funds for Distressed Assets: They invest in companies that are facing financial difficulties but can soon make a turnaround.
• Debt Funds: The debt funds invest in debt instruments of listed or unlisted companies. They are relatively less risky than the private equity funds.
• Fund of Funds: FoFs do not invest in the equity or debt of companies instead they invest in other AIFs.

3. Category III AIFs

Category III AIFs deploy diverse or complex trading strategies and take leverage by investing in listed or unlisted derivatives.

• Hedge Funds: These funds invest and trade in different markets, strategies, and instruments including securities, non-securities, and derivatives.
• PIPE Funds: Private Investment in Public Equity (PIPE) funds invest in listed companies’ equity at a lower price than the market in a private deal.

Eligibility Criteria for AIF Investment

1. The minimum investment amount for an investor in the AIF fund is set at ₹1 crore. In the case of employees, directors, and fund managers, then the minimum investment amount is ₹25 lakhs.
2. Angel funds have a minimum investment amount of ₹25 lakhs for a maximum period of 3 years.
3. Category I and II Alternative Investment Funds (AIFs) are close-ended with a minimum investment tenure of 3 years while Category III AIFs can be either open-ended or close-ended.
4. All AIF funds can have a maximum of 1,000 investors while angel funds can pool money from a maximum of 49 investors.
5. After meeting the minimum investment amount of ₹1 crore, the AIF fund can pool money from Indian, foreign, or NRI investors.

Alternative Investment Funds: Pros and Cons of Investing

AIFs provide several benefits to high-net-worth individuals looking to invest in unconventional investment options.

1. Chances of High Returns: Alternative investment funds can generate higher-than-average returns as the fund manager can strategically invest in unconventional or unique instruments like private equity, start-ups, and infrastructure projects.
2. Unlinked to Broader Market: These funds are generally less volatile as they are unlinked to broader market performance. Due to their unique investment style, the fund manager can make active decisions to manage risk.
3. Portfolio Diversification: AIF funds help HNI and sophisticated investors invest in private equity or debt that is not part of their portfolio. This helps them to expand their portfolio and generate returns from multiple sources.
4. Fund Manager Expertise: AIFs are managed by professional fund managers who can select the right instruments based on their experiences. It means that the investor can get the unlisted equity or debt securities without doing personalized research.

However, Alternative investment funds are also prone to various challenges such as higher initial capital, limited liquidity, higher fee structure, and exposure to high-risk instruments.

SEBI’s Moves to Protect Investor’s Interest in AIFs

AIF regulations are continuously evolving to keep up with the investor’s interest based on how the fund invests and distributes returns.

• Fair Rights for Investors: In this one, SEBI has emphasized that the investor’s risk and returns in AIFs must be in proportion to the investment made by him in a fund. If an investor has invested 15% of the total capital in AIF, then they should get 15% of all the returns generated by the fund.
• Pari-Passu Rights for Equal Treatment for Investors: Alternative investment funds pool money from multiple investors and the fund should follow fair and equal treatment for investors in giving rights or share of returns. The differential rights (high returns or different fee structure) can be given to selected investors only if it is approved by SEBI wherein other investors should not be negatively affected.
• Large Value Funds: Large value funds (those with high capital or large individual investor contributions) can follow the differential rights if each investor agrees to the said conditions.

Taxation Rules of Alternative Investment Funds

In the Budget 2025, the government has provided clarity on the Category I and II AIFs taxation. The income generated from these AIFs will be considered capital gains and will be taxed at 12.5% in the hands of investors. If the gains are marked as business income, then they will be taxed at 30% for resident individuals and up to 39% for non-resident individuals.

The income from Category III AIFs is not given the pass-through status. It means that you will get the income after deducting the required taxes. At the fund level, the gains are taxed on the basis of the type of income such as LTCG, STCG, dividend income, business income, and interest income.

Conclusion

Alternative Investment Funds (AIF full form) are suitable for high-risk investors such as HNIs that have huge initial capital to invest in. Those who are looking to invest beyond mutual funds or stocks can surely go with AIF investment. However, understanding the risk, fund investments, valuations, and fees is important to study before making a decision.

Frequently Asked Questions – FAQs

1. What are alternative investment funds?

Alternative investment funds are the type of pooled investment vehicles that collect money from HNIs and institutional investors and invest across private equity, unlisted debt securities, start-ups, infrastructure projects, and real estate.

2. What are the top 5 AIF funds in India?

The top 5 AIF funds in India that have generated whopping returns in 2024 are:

• Finavenue Growth Fund – 132%
• Negen Undiscovered Value Fund – 57%
• Growth Opportunities Fund Scheme – 48%
• Growth Anchors Fund – 48%
• Structural Shift Fund – 47%

Is AIF better than MF?

AIF is made for HNIs that can invest a minimum of ₹1 crore while mutual funds are for small investors with a minimum investment of ₹500. AIF investment is suitable for those who want to explore unlisted securities and mutual funds are for those who want to invest in stocks and bonds.

Reference:
https://www.sebi.gov.in/sebi_data/attachdocs/1471519155273.pdf

Author: All Content is verified by SMC Global Securities.