Alternate Investment Funds (AIFs) Explained: Types, Benefits & Risks

As Indian investors seek diversification and access to unconventional opportunities, Alternate Investment Funds (AIFs) have gained popularity. These privately pooled investment vehicles cater to high-net-worth individuals (HNIs) and institutional investors, offering access to assets like private equity, venture capital, real estate, hedge funds, and more. Regulated by the Securities and Exchange Board of India (SEBI), AIFs enable portfolio diversification but come with unique structures, strategies, and risks. This article explores what AIFs are, their types, benefits, eligibility, and key considerations for investors.

AIFs are privately pooled investment vehicles that collect funds from investors to invest according to a defined investment policy.

They differ from mutual funds in terms of strategy, asset class, regulatory framework, and investor profile.

AIFs are regulated under SEBI (AIF) Regulations, 2012, and are typically not open to retail investors due to their complexity and higher risk appetite.

Here are the key features that define how Alternative Investment Funds (AIFs) function and who they are suited for:

SEBI classifies AIFs into three categories, each with distinct investment objectives and risk profiles.

Category I AIFs

These funds invest in socially or economically desirable sectors and are encouraged by regulators.

Examples:

• Startups
  

• Early-stage ventures
  

• Social ventures
  

• SMEs (Small and Medium Enterprises)
  

• Infrastructure funds
  

They typically attract government or regulatory incentives and have longer horizons.

Category II AIFs

These do not receive incentives or leverage but follow complex strategies beyond traditional investments.

Examples:

• Private equity funds
  

• Debt funds
  

• Fund of funds (FoFs)
  

• Distressed asset funds
  

These are the most popular AIFs in India, especially for investors seeking medium to long-term growth.

Category III AIFs

These employ diverse or complex trading strategies and may invest in listed or unlisted derivatives for short-term returns.

Examples:

• Hedge funds
  

• Long-short funds
  

• Arbitrage funds
  

They can use leverage and are subject to tighter scrutiny due to higher risk exposure.

To understand how AIFs function, it’s important to know the roles of the key entities involved in their structure:

Fund Manager

Designs investment strategy and manages the fund.

Trustee or Custodian

Holds the fund’s assets and ensures regulatory compliance.

Sponsor

Sets up the fund and contributes at least 2.5% of the fund corpus or ₹5 Cr, whichever is lower.

Investors

Minimum investment of ₹1 Cr per person. Usually HNIs, family offices, or institutions.

Funds operate as close-ended structures with tenures ranging from 3 to 10 years, extendable by mutual consent.

These advantages make AIFs an appealing option for sophisticated investors looking beyond traditional stocks and bonds.

Diversification

Access to non-traditional assets like private equity, real estate, or commodities that may not correlate with public markets.

Customised Strategies

Each AIF has its own tailored strategy targeting specific outcomes—growth, income, or alpha generation.

Professional Management

Run by experienced fund managers and supported by research teams and legal advisors.

Tax Efficiency (In Some Cases)

Certain AIFs (particularly Category I and II) offer pass-through taxation, where tax is applicable only at investor level, avoiding double taxation.

Access to Unlisted Assets

Investors can gain exposure to high-growth businesses before they go public.

Investors must carefully assess the fund’s objective, strategy, team, and fees before committing capital.

AIFs are not meant for short-term goals or capital safety, unlike many mutual fund schemes. Here’s how they differ:

Tax implications depend on fund structure, asset class, and holding period.

• Category I & II:
  Pass-through status; investors pay tax as per their income slab on gains.
  

• Category III:
  Taxed at the fund level. Capital gains and business income are taxed according to applicable rates, often making them less tax-efficient.

AIFs cater to a niche audience—those seeking differentiated returns through alternative asset classes. Let’s explore who they’re best suited for.

• Investors with a long-term horizon and high-risk tolerance
  

• Those looking to diversify beyond listed equities and fixed income
  

• Investors seeking exposure to startups, real estate, or structured credit
  

• Family offices and institutions managing large portfolios
  

These products are not designed for new or conservative investors.

Before proceeding, it’s important to evaluate whether an AIF aligns with your financial goals, risk tolerance, and investment horizon.

Check SEBI Registration

Ensure the fund is listed in SEBI’s list of registered AIFs.

Assess Fund Strategy and Structure

Review the offering memorandum and risk disclosures.

Meet Eligibility Requirements

Minimum investment of ₹1 Cr; Know Your Customer (KYC) compliance mandatory.

Invest Through Authorised Platforms or Distributors

Most AIFs are distributed through private wealth managers or financial institutions.

Understand Fees and Charges

Includes management fee (typically 1.5–2.5%) and performance fee (profit-sharing).

Alternate Investment Funds offer unique opportunities for portfolio diversification and potential outperformance, especially in niche and high-growth sectors. However, their complex structure, long lock-ins, and higher risk make them suitable for experienced investors only. A well-researched approach, along with professional advice, is essential before committing capital to an AIF.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.