The Securities and Exchange Board of India’s Regulation Act, 2012 defines Alternative Investment Funds as a type of investment distinct from traditional investment options such as stocks, bonds, and other debt securities. Alternative Investment Funds can form as a corporation, a trust, or a Limited Liability Partnership (LLP).
Alternative Investment Funds (AIFs) are an increasingly popular investment option among high-net-worth individuals and organizations looking for diversification and higher returns than traditional investment options. AIFs pool investments from multiple investors to invest in various asset classes such as venture capital, private equity, hedge funds, managed futures, and other alternative investment vehicles.
Types of Alternative Investment Funds (AIFs):
AIFs can be categorized into three categories: Category I, Category II, and Category III, based on their investment strategies and objectives.
Category I:
Category I AIFs invests in start-up or social enterprise funds, infrastructure funds, SME funds, and other similar investments. For the government or regulators, they are often deemed socially or economically viable.
This category includes funds that invest in start-ups, small and medium-sized firms (SMEs), and new businesses with strong growth potential and are socially and economically viable. Because these ideas have various effects on the economy, the government encourages investment in them. These funds have proved a lifeline to already-successful firms in need of funding.
- Venture Capital Funds (VCFs) are one of the types of Category I AIFs. VCFs invest in high-growth start-ups that experience cash constraints in the early stages of their business and require capital to develop or expand their operations.
They invest in a variety of businesses based on their company characteristics, asset size, and product development stage. Unlike mutual funds and hedge funds, venture capital funds concentrate on early-stage investments. Each investor receives a proportional share of the firm that the VCF has invested in, based on their investment.
- Infrastructure Funds (IFs) are another type of Category I AIFs. The fund invests in public assets like road and rail infrastructure, airports, and communication assets, among others. Investors positive about future infrastructure growth can participate in the fund since the infrastructure industry has high entry barriers and little competition. Infrastructure Fund investors might expect a mix of capital growth and dividend income as a result of their investment. When an Infrastructure Fund invests in initiatives that are socially acceptable and practical, the government may offer tax incentives.
Category II:
Category II AIFs are funds that do not use leverage or borrow for any reason other than to cover operational needs that do not fall under Categories I or III.
- This is where Private Equity Funds fall. PE funds invest in private firms that aren’t publicly traded by stakeholders. Because unlisted and unauthorized private enterprises are unable to raise cash with PE funds for help. Furthermore, these organizations provide their clients with a diverse portfolio of shares, lowering the investor’s risk. A defined investment horizon of 4 to 7 years is usual for a PE fund. The company hopes to exit the investment with a decent profit after seven years.
Category III:
Funds that engage in a variety of complex trading techniques, such as investing in listed or unlisted derivatives, fall into Category III. Hedge funds are typically included in this category. Open-ended funds are classified as Category III AIFs, whereas closed-ended funds are classified as Category I and II AIFs.
- Angel Funds are Category III AIFs. Angel funds are a type of Venture Capital fund in which fund managers combine money from a number of “angel” investors to invest in early-stage firms. Investors receive dividends when new enterprises become profitable. Units are distributed to angel investors in the case of Angel Funds. An “angel investor” is an individual or group of individuals who invests funds in early-stage startups in exchange for equity in the company.
- Hedge Funds, which are included in Category III AIFs, are investment funds that use a variety of trading strategies to generate high returns. Hedge funds employ a wide range of techniques, including short selling, leveraging, and derivatives trading. Hedge funds are known for their ability to produce high returns even in difficult market conditions.
- Real Estate Funds, which are also included in Category III AIFs, invest in real estate projects such as shopping malls, residential buildings, and commercial properties. Real estate funds typically generate income through rent or sale of the underlying property.
Category III AIFs are subject to more regulatory oversight than Category I and II AIFs due to the increased complexity of their trading strategies. SEBI, the Securities and Exchange Board of India, has imposed several rules and regulations on Category III AIFs to safeguard investors’ interests.
Benefits of Investing in AIFs
- Customizable
The structure of an AIF can be tailored to fit a specific investing strategy, whether it’s exposure to a single sector or diversification across asset classes. This allows investors to create a portfolio that aligns with their investment goals and risk tolerance.
- Raising Resources and Flexibility
AIFs can raise funds from any investor, whether Indian, foreign, or non-resident Indian (NRI). This allows AIFs to tap into a wider pool of capital, which can be used to meet certain investment goals.
- Passive Investments
Many investors value their time highly and prefer passive investments that require little effort to manage. AIFs provide investors with the opportunity to invest in assets that require little to no effort to manage.
For example, if an investor invests in a real estate AIF, the AIF’s management team takes care of all aspects of the investment, including property management, maintenance, and leasing. This allows investors to enjoy the benefits of investing in real estate without having to worry about managing the property themselves.
- Uncorrelated to Stock Market
One of the main benefits of investing in AIFs is that they are often uncorrelated with the stock market. This means that if the stock market experiences a sharp decline, AIFs can act as a hedge of protection. The entire investment portfolio will be unaffected. This is because AIFs invest in private alternatives, which are mostly immune to public market volatility. As a result, investors can diversify their portfolios and hedge against volatility.
- Direct Ownership
AIFs provide investors with the opportunity to invest directly in assets such as real estate, art, and wine. This means that investors can own the assets, which can potentially provide better returns than paper assets. When investing in AIFs, investors can acquire a mortgage note, own a rental property outright, or even purchase a bottle of wine or an oil painting directly. This type of direct ownership is not possible with traditional investment funds.
Looking to invest in Alternative Investment Funds?
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