A Beginner’s Guide To Alternative Investment Funds (AIFs)

Alternative Investment Funds(AIF) are in high demand among HNIs and institutional investors, and India’s investment landscape is growing at a fast pace. The asset size of the AIF market in India had reached ₹6.94 lakh crore as of the end of March 2024, having grown at an approximate rate of 30% every year. AIFs attract this investor class as they are seeking higher returns and more diversified options beyond the standard stocks and bonds. This white paper takes a broad overview of AIFs-they cover different types, key regulations, and how to register an AIF-on the last page of which you’ll learn how to assess whether AIFs match your goals.

What Are Alternative Investment Funds (AIFs)?

An AIF, is a privately pooled investment vehicle that collects funds from sophisticated investors for investment into securities other than traditional equities and bonds. It can be said that the regulations and rules of the AIFs in India under SEBI (Alternative Investment Funds) Regulations, 2012, have become the epitome of an important addition to the investment ecosystem by chipping in towards infrastructure, even through startups and distressed assets.

Key Features of AIFs:

• Pooled Investment: Numerous investors contribute funds to be professionally managed by the fund managers.
• Other, not-so-conventional asset classes: They invest in alternative assets like private equity, hedge funds, real estate, and venture capital, among others.
• Designed for HNIs: AIFs, with minimum ticket sizes of ₹1 crore, are primarily available to high-net-worth individuals (HNIs), family offices and other institutional investors.

Types of Alternative Investment Funds

AIFs have been categorized into three, which cater to different types of investors and regulatory regimes.

Category I AIFs

These types of funds invest in social or economic activities such as start-ups, infrastructure, and SMEs. Category I AIFs are often exempted from certain regulations as they contribute to the country’s economic development.

Some of the Key Types

• Venture Capital Funds: This type of fund mainly focuses on early-stage businesses that have a high potential for growth.
• Infrastructure Funds: This segment would include the infrastructure developing projects of roads, bridges, power plants, etc.
• Social Venture Funds: These would raise financial returns in addition to some social returns.

Category II AIFs

Category II AIF is not exposed to any of the preferential or special privileges/controls of SEBI. Chiefly these consider the instruments of equity and debt.

Major ones are:

• Private Equity Funds: Invests in a company that is unquoted publicly, or will require a controlling share such that the companies can utilise those for attempting to make decisions over business lines.
• Debt Funds: Invest in debt securities including corporate bonds, debentures, and structured debt instruments.

Category III AIFs

These funds are using sophisticated strategies which include leverage and derivatives. Most of the funds fall in the category of hedge funds.

Key Features:

• Short-Term Orientation: It is using the strategy of short-term gain through trading in derivatives and arbitrage.
• High-Risk, High-Return: These funds are meant for investors with a high risk appetite.

Growth of AIFs in India

According to reports from SEBI, the AIF sector in India has grown in leaps and bounds. Total commitment rose from ₹2.05 lakh crore in March 2019 to over ₹6.94 lakh crore in March 2024. The demand for diverse investment instruments beyond traditional vehicles like mutual funds and equity stocks seems to be building up.

• Startups & Venture Capital: Category I AIFs have emerged as a crucial source of funds for the Indian startup ecosystem, and more than ₹35,000 crore was raised through venture capital funds alone in 2023.
• Infrastructure Development: Category I infrastructure funds are gaining pace with large-scale infrastructure projects in the foreground due to government initiatives.

Regulatory Framework for AIFs

SEBI governs AIFs so that investors would not suffer, and it would keep the market stable and transparent at its best.

SEBI (Alternative Investment Funds) Regulations, 2012 elaborates with guidelines regarding fund managers and investors with regard to this kind of investment.

The key requirements set by these regulations include the following,

• AIF Registration: In order to work, an AIF needs to get registered before SEBI.
• Minimum Corpus: To become operational AIF must hold a corpus of Rs 20 crore.
• Investment Restrictions: For instance, Category I and II AIFs cannot invest more than 25% of their corpus in one entity, thereby diversifying the portfolio.
• Limits on Leverage: Category III AIFs may use leverage, though SEBI has prescribed certain limits.

Benefits of Investing in AIFs

AIFs offer numerous advantages, especially for the savvy investor who wants to have access to various classes of assets and strategies.

• Diversification: AIFs enable investors to diversify in asset classes like real estate, private equity, and startups which are otherwise unavailable through traditional funds.
• Potential for High Returns: The AIF managers focus on sectors with high growth prospects, such as venture capital or distressed assets, which can yield outsized returns.
• Professional Management: Being managed by professionals who are experienced in alternative investments reduces risks since it will be channelled strategically.

Risks of AIFs

Although they provide luscious opportunities, AIFs involve certain risks:

• Illiquidity: The lock-in period of an AIF is usually longer, even up to 7-10 years.
• Higher Risk: This moves to a higher risk level since the investments are, in fact, startups or distressed assets. AIFs are therefore much more dangerous than the traditional ones such as mutual funds.
• Regulatory Risk: An amendment in SEBI rules can have an immediate and direct effect on the performance of the AIF and, consequently, on the returns on investment.

How to Register an AIF in India

There exists a structured regulatory process framed by SEBI to enable AIF registration. The steps for AIF registration can be described as below.

• Incorporate the Fund: The fund is supposed to be incorporated in a company, LLP, or a trust.
• File an Application: An application regarding the same needs to be submitted by the AIF along with all the necessary documents such as the details about the sponsor, manager, and trustee.
• Approval: Once the SEBI receives and processes your application, the registration takes place in SEBI’s AIF database whereupon the AIF commences its operations.
• Compliance: Following all the regulations set in by SEBI, files are submitted and disclosed properly from time to time for SEBI compliance.

Pro Tip: NBFC Advisory offer service that makes AIF Registration and Compliance hassle free so that your fund shall stay SEBI complaint too.

Who should invest into AIFs?

AIFs are designed for sophisticated investors who understand the play of risk and reward. Normally, AIF investors include:

• High-Net-Worth Individuals (HNIs)
• Institutional Investors
• Family Offices
• Corporate Entities

How to Choose the Right AIF

When choosing an AIF, ensure that the investment strategy of the fund matches your financial goals and risk tolerance. Here’s how you can evaluate your options:

• Set Your Investment Objectives: Do you want short-term returns, long-term wealth building, or diversification?
• Risk Assessment: Determine the risk level of each AIF category and ensure it is in line with your risk tolerance.
• Track Record of Fund Manager: Always look at the performance history and credibility of the fund manager before making a decision.

Conclusion

Alternative Investment Funds or AIFs are something exciting and a growing investment opportunity for sophisticated investors seeking diversification beyond traditional assets to achieve superior returns. They can make investments in non-traditional assets, such as startups, real estate, and distressed companies, but with opportunity comes risk. Knowing the categories, frameworks, and registration process will help effectively navigate this space.

If you ever plan to set up an AIF or invest into one, NBFC Advisory will help you through this process from registration of the AIF till compliance. Now, let’s get moving towards smarter and diversified investments today!

Do you have questions about AIF registration or AIF regulations? Please leave your comment below, and we’ll be glad to assist! If you found this guide helpful, share it with your network. For more expert advice on setting up or managing AIFs, contact NBFC Advisory today.