What Are Alternate Investment Funds (AIFs)- All You Need Know

If you are looking for investments other than traditional ones, such as cash, bonds and stocks, alternative investment funds are a great way to invest. AIFs may offer a better return than conventional options but require more investment and are riskier than mutual funds. These funds target sophisticated investors such as high-net-worth individuals (HNI) from India and globally with a large sum to invest. 

Alternative Investment Funds (AIF) refers to privately pooled investment funds which can be from Indian or foreign source. AIFs can be in the form of a trust or a company or a body corporate or a Limited Liability Partnership (LLP).

What are the different types of AIFs in India?

The Securities and Exchange Board of India (SEBI) has divided Alternative Investment Funds into three categories:

Category 1: This category pools money from various investors and invests in startups, SMEs and some economically viable corporations which are new in the market and have high growth potential. These funds include:

• Infrastructure Funds: As the name suggests, these funds invest in companies that are primarily engaged in the business of infrastructure, such as the construction of railways, airports, ports etc. Investors who are interested in the sector generally invest in these funds.

• Venture Capital Funds (VCF): These funds invest money into businesses with high capital requirements. Generally, HNIs who have a higher risk appetite invest in these funds.

• Angel Funds: These funds invest money into new startups that do not receive any funding from venture capital funds. Each angel fund investor typically allocates minimum financing of Rs. 25 lakh. 

• Social Venture Funds: These funds invest money into socially responsible businesses who generally take part in philanthropic activities and provide decent returns to investors.

 Category 2: These include Alternative investment options such as private equity or debt funds with no fixed incentives provided by the government or any regulator. These funds include:

• Debt Funds: These funds put money into debt securities of unlisted companies that follow good corporate governance models and have growth potential. They have less credit rating comparatively and are not suitable for conservative investors.

• Funds of funds: These funds invest their money into other Alternative Investment Funds.

• Private Equity Funds: These funds invest in unlisted private businesses that need help in raising capital by issuing debt and equity instruments.

Category 3: This category includes funds that use advanced trading strategies, such as hedge funds and private investment in public equity funds which may be leveraged; this category includes:

• Hedge Funds: These funds pool money from investors and corporates to invest in a combination of debt and equity instruments in domestic and international markets. The fund managers follow an aggressive strategy and provide higher returns on investments. At the same time, they have a higher expense ratio and are riskier.

• Private Investment in Public Equity Fund (PIPE): These funds invest money into public firms by purchasing their shares at discounted prices. 

Also Read: A Guide for Partnership Firm Tax Rate

Who can Invest in Alternative Investment Funds?

Investors who are looking to diversify their portfolio can invest in AIFs; they should meet the following criteria:

1. Indians, NRIs and foreigners are eligible to invest in these funds.

2. The minimum investment amount of these funds is on the higher side, a minimum of Rs. 1 crore for investors. On the other hand, directors, employees and fund managers can invest in these funds with a minimum amount of Rs. 25 lakh.

3. These funds typically have a lock-in period of a minimum of three years.

4. AIFs are restricted to only 1,000 investors in each fund except angel funds, where the specified number of investors is only 49.

Taxes on Alternative Investment Funds 

1. Income from Categories 1 and 2 are taxed as per your current tax slab and are not subject to taxation on their own. 

2. If the AIF has its exposure to equities, you must pay a capital gain tax of 10% for the long term and 15% for the short term.

3. Category 3 funds are taxed at a maximum marginal rate of 42.7%; you get your earnings after this deduction.

SEBI’s Regulations on Alternative Investment Funds

The SEBI has implemented some restrictions on AIF, which you must be aware of before investing in the schemes:

1. For venture capital funds, allocating a minimum of 75% of the capital to equity-linked instruments and unlisted equities is compulsory. At the same time, these investments must be companies of venture capital undertaking or businesses listed in the SME section of exchanges.

2. The minimum amount of Rs. 25 lakh for accredited investors only applies to grants received while allocating the money into social venture funds.

3. Category 3 AIFs can invest 10% of their capital in a firm, including hedge funds and private equity funds. 

Benefits of investing in Alternative Investment Funds

1. Limited  with the Stock Market: Every long-term investor who has invested in the stock market for a long term must have seen volatility, and witnessing the portfolio in losses gives much pain. Investing in AIFs is a great way to protect your portfolio from stock market volatility. 

2. Portfolio Diversification: AIFs allocate the investor’s money into different assets, providing excellent portfolio diversification.

3. Returns: Investing in AIFs is profitable as these funds have various investment options. They can be a better source of passive income than traditional investment options.

Wrapping Up

Alternative Investment Funds are a great source of investing for investors, including HNIs who seek higher returns and have a higher risk appetite.

Frequently Asked Questions (FAQs)