Alternative Investment Fund (AIF)

Alternative Investment Fund:

Many investors, especially HNIs, are looking beyond equity and bonds for investment. For them, an Alternative Investment Fund (AIF) is one option worth considering. These investment options can deliver higher returns than a traditional investment. They carry higher risk - more than equity (in general). The funds target HNIs, but it is expected that they will also be available to midsize retail investors. 

The Indian AIF industry stood at Rs 6.4 lakh crore as on 31st March 2022, an incredible 7X growth in the past five years. It shows there is high interest among investors in India. 

What is AIF?

The term "alternative investment fund" refers to the collection of pooled investment funds that infuse in hedge funds, private equity, venture capital, and other investment types. An Alternative Investment Fund can be established through a company or a Limited Liability Partnership (LLP).

Types of Alternative Investment Funds (AIF)

You can better understand AIF by learning about its categories. AIF is put into three categories, as per the Securities and Exchange Board of India (SEBI). Below are those categories:

Category 1: Under this category, the AIF can invest in SMEs, start-ups, and new economically viable corporations with high growth potential. The different funds in this category include:

• Infrastructure fund: These invest in companies engaged in infrastructural works like constructing airports, railroads, etc.
• Venture Capital Funds (VCF): The fund invests money in promising entrepreneurial businesses that need large amounts of capital.
• Angel funds: It invests in new-age start-ups that do not receive investment from VCF. Each angel fund investor allocates a minimum of Rs 25 lakh.
• Social venture fund: The fund puts money into businesses that come under philanthropic activities. They aim to bring a change in society through investments.

Category 2: Funds do not use leverage for any reason other than to cover operational needs that do not fall under categories 1 and 3. Below are the funds under this category:

• Debt funds: These funds invest in the debt securities of unlisted companies that the fund believes follow good governance models and have good growth potential.
• Funds of funds: Under this option, the money goes into other alternative investment funds.
• Private equity fund: Private equity funds invest in unlisted businesses that face problems raising capital by issuing debt and equity instruments.

 

Category 3: Funds that engage in many complex trading techniques, for example, investing in listed or unlisted derivatives. Below are the funds under this category:

• Private Investment in Public Equity Fund (PEF): These funds invest in public firms by buying their shares at discounted prices. 
• Hedge funds: They collect money from investors and corporations to invest in equity and debt markets both on the domestic and international levels. These schemes follow an aggressive investment strategy to provide a higher return to their investors.

Who can invest in an AIF?

Below are the criteria for AIF investing:

• Indian residents, NRIs, and foreign nationals can invest in AIFs.
• The minimum investment limit is Rs 1 crore for investors. For directors, employees, and fund managers, the minimum limit is Rs 25 lakh.
• Most AIFs have a minimum lock-in of three years.
• The number of investors in every scheme is restricted to 100. For angel funds, the number of investors goes up to 49.

Why invest in AIFs?The number of investors in every scheme is restricted to 100. For angel funds, the number of investors goes up to 49.

 Why invest in AIFs?

Below are some benefits of investing in AIFs:

Diversification: Diversification is key for every investor. It is even more crucial for HNIs who have large ticket sizes. AIF allows investors to diversify their portfolios. They act as a cushion in times of market volatility.

High returns: AIFs can deliver higher returns to investors compared to other options. The massive pooled amount allows fund managers to prepare flexible strategies for maximizing returns.

Low volatility: AIFs are unlinked with the stock market. Therefore, the volatility is less in these funds - if you compare it with traditional equity investment (obviously, not without the risk).

Tax benefits of AIFs-

Alternative investments offer significant tax advantages. Because of the structure of alternative funds, you get to keep more of the profit made. 

The AIF taxation will depend on and vary according to the category. For example, for categories 1 & 2, there is a pass-through status. It means the income (or loss) generated by the fund will be taxed at the investor's hand and not by the fund business. In short, under these two categories, you need to pay capital gains tax on profits made. For Category 3, different rates are applicable depending on profit type.

Conclusion

AIFs are an interesting option for investors looking for high returns with a certain level of risk. However, before investing in AIFs, investors must carefully understand the fund and know the associated risk. Small retail investors can continue to learn about this option as it is expected that AIFs will open to retail investors in the coming years.