Alternative Investment Funds

Alternative investment funds, as the name suggests, are an investment option for private investors who have funds of more than ₹1 crore to invest. The investments are made in non-traditional assets instead of regular securities which is why these funds are called “ Alternative “ investment funds. 

In this article, we are going to look at alternative investment funds, their categories, their products, how they are taxed, who regulates them, how much returns do different AIFs give, what is the minimum amount required to invest in different AIF products, and how are they different from other pooled investment options. 

So let’s hang tight with us till the very end as we bring you everything you need to know about alternative investment funds. 

Alternative Investment Funds India

In a scenario when an investor wants to invest in something that they can’t afford to invest in at an individual level, they surrender their funds to a pool where more like-minded people with the same investment goal do the same to create a pool fund. This pooled fund is then managed by a professional and experienced fund manager who decides to invest the fund into several assets to book maximum profits. 

Let us take a real-life example of it. 

In your childhood, you must have played cricket. Do you remember the procedure when you needed to buy a new ball? Every team member used to contribute some small amount of money and make a pooled fund which eventually was used to buy a ball. 

Similarly in Alternative investment funds, the pooled money is used to purchase and invest in different assets. 

The alternative investment funds invest in assets like: 

• Infrastructure 
• Ownership of startup companies
• Shares of social welfare companies
• Small to medium-sized enterprises
• Portfolio of other Alternative investment funds
• Shares of the companies that have already been traded on an exchange
• Debt securities of the companies with low credit scores but high growth potential 
• Real Estate
• Tangible assets 
• Shares of unlisted companies 

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Types of Alternative Investment Funds 

This investment option holds many benefits and advantages and one such is the wide variety of AIF products, that help an investor to choose the one as per their risk appetite and return percentage.

To make it easier to understand and to pick the best option for investment, there are three major categories.

Each category has its own advantages and risks. Let’s have a look at each of these categories one by one.

Alternative investment funds Category 1

This AIF category focuses on investments that don’t only reap rewards for them but also aid economic and social developments. There are four products under AIF category 1 – Social Venture funds, SME funds, Venture Capital Funds, and Infrastructure funds. 

 

Alternative investment fund Category 3

Before we move to AIF category 2, we will look at AIF category 3. AIF category 3 uses complex and diverse trading strategies to leverage profits. It deals with investing in the securities and derivatives of listed as well as unlisted companies and hence, is considered highly risky. 

Under this category, there are two AIF Products – Hedge Funds and PIPE (Private Investment in Public Equity).

 

Alternative investment fund Category 2

All those products that are neither categorized under category 1 nor category 3 by SEBI are put under AIF category 2. This AIF category has 3 products – Private Equity Funds, Debt Funds and Fund of Funds. 

 

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Alternative Invested Fund Regulated By

Alternative investment funds are regulated by the Securities and Exchange Board of India (SEBI) under the AIF regulations act 2(1) (b), 2012 for a fair and transparent functioning of these funds. The act was later amended in 2021. 

According to this act, all the operational AIFs need to be registered with SEBI. 

Alternative Investment Funds Tenure

Alternative investment funds are divided into two parts in terms of tenure. They are either close-ended or open-ended. 

• Open-ended: The funds are invested without a lock-in period and can be withdrawn in the short term.
• Close-ended: The funds are invested with a lock-in period, usually 3 to 5 years in the case of AIFs. 

Alternative investment funds category 1 and category 2 are strictly close-ended while AIF category 3 can either be open-ended or close-ended. 

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AIF Minimum Investment 

Now when it comes to investments in different AIF products, SEBI has mandated a rule that requires the investors to have a minimum investment amount and the fund to have a minimum corpus. 

An investor can only invest in an alternative investment fund if they can invest at least ₹ 1 crore. For someone who is an employee, manager, or director of an AIF, the minimum investment amount is kept at ₹ 25 lakh.

Similarly, the minimum corpus of the fund must be ₹ 20 crores for a successful investment. 

However, there is an exception to this rule. 

Angel fund

Angel fund is basically the private fund of an investor who wants to buy the equity of a startup company alone instead of surrendering their funds into a pooled fund. The investor, in this case, is called an Angel investor. 

An angel investor invests with the purpose of buying a major stake in the company at a very early stage and then making profits with its growth. 

In the case of Angel funds, the minimum investment is ₹ 25 lakh but the investor must have a net worth of at least ₹ 2 crores where their primary residence is not counted. 

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AIF Returns

When it comes to the returns on these investments, alternative investment funds vary differently just like their investment horizon. Since a lot of them don’t depend upon the stock market for their returns, they are considered a lot safer investment options. 

Infrastructure funds yield the highest annual return with 75% while most of the AIF products give returns in the range of 10-15% with Private Equity funds and Fund of funds being a couple of exceptions. 

Private equity funds give an average annual return of 25%-30% while Fund of funds, which is a relatively safer investment choice gives a return up to 4%. 

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AIF Taxation

The Securities and Exchange Board of India (SEBI) has taxed Alternative investment funds on the basis of a couple of scales. The first scale of taxation is the AIF category and the second is the legal form of an AIF. 

AIF Taxation Based on Category

AIF Category 1 and category 2 have been granted a pass-through status which means they don’t have to pay any taxes at the fund level while AIF category 3 is charged at the fund level, according to the highest income tax slab currently. 

Investors of AIF category 1 and AIF category 2 are taxed at an individual level over capital gain or loss depending upon whether their investments are long-term or short-term. 

AIF Taxation Based on Legal Form

Alternative investment funds can take four legal forms and the taxation depends upon these three forms only. 

• When an alternative investment fund is set up as a company, an investor is taxed as per the tax on the dividend income. 
• When an AIF is set up as an indeterminate trust, where the shares of beneficiaries are not known, the AIF is taxed at the fund level according to the highest income tax slab.
• When an AIF is set up as a determinate trust, then it is taxed at the fund level only but the taxes are paid by combining the tax shares of each member. 
• When AIF is set up as a Limited Liability Partnership (LLP), then the investor doesn’t have to pay any tax on any share of profits received by them from the LLP.

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 Best AIF in India

How do you judge which is the best alternative investment fund for you? It’s simple. All you have got to do is to judge every AIF on 5 parameters – category, strategy, periodic returns, returns since inception, and the experience of the fund managers. 

The AIF category as well as the strategy should be aligned with each other and should suit your investment goals while periodic returns and returns since inception give you an idea about the performance of the fund over the years.

The experience of the fund managers is also vital as it helps them make wiser decisions. 

Based on these parameters, here are some of the best alternative investment funds in India. 

 

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MF Vs PMS Vs AIF

Now the next question that arises in mind is, how is an Alternative investment fund different from other similar investment plans like mutual funds and portfolio management services (PMS)? After all, both the investment models of AIF and MF work on the same structure of investing a pooled fund into purchasing some assets. 

Well, there are some major differences among the three and we are going to look at them here now. 

 

• From the above table, one can clearly understand alternative investment funds vs mutual funds, how the two investment products differs in terms of investment and taxation.  
• For long-term capital gain in Debt funds and hybrid debt-oriented funds, investors are charged 20% tax + surcharge. 

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AIF Benefits

As we learned from this article, there are several benefits that you enjoy while investing in an AIF.

• Flexible: Alternative investment funds are flexible which means you either choose a close-ended or an open-ended fund depending on your style. 
• Huge corpus size: A minimum corpus of ₹ 20 crores ensures that your fund is invested in your dream projects and lack of money doesn’t come its way. 
• Tax exemption: While investing in AIF category 1 and category 2, there is no tax on the fund level and investors just have to pay taxes on the capital gain. 
• Limitless: Anyone, be it an Indian citizen or an NRI or a foreign individual can invest in alternative investment funds. It sees no boundaries. 
• Skillful and experienced fund managers: You also get professional fund managers who not only take care of your money but also grow it using their expertise. 

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Conclusion

“ How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” — Robert G. Allen, Investment advisor. 

With India being an economy that has been growing ever since the liberalization in 1991, it has opened up multiple investment options for retail as well as sophisticated investors. People are no longer investing in just a limited amount of options as different pooling funds options, especially alternative investment funds have expanded the entire investment horizon with diverse investment options. 

It gives the investors an opportunity to invest in their dream projects even when they don’t have enough funds. All they have to do is to merge their funds into a pooled fund and that’s it! Their fund, combined with the funds of other investors in the pool is used by a professional fund manager to invest in various attractive investment options. 

Alternative investment funds are a relatively new concept in India with the SEBI regulation coming into effect in 2012 itself. Therefore, people, especially beginners, might find it a little difficult to grasp its concept at first but we hope this article has helped you learn about AIF in detail. 

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