Alternative Investment Funds (AIFs)

What Are AIFs?

AIFs differ from mutual funds as they invest in assets not typically available in public markets. These funds are usually structured as closed-end vehicles, with a minimum investment of ₹1 crore, except for accredited investors who may have lower thresholds.

Types of AIFs in India

1. Category I AIFs:

   • Focus on socially or economically desirable sectors, such as startups, SMEs, and infrastructure.

   • Includes venture capital funds, SME funds, and social impact funds.

2. Category II AIFs:

   • Includes private equity, debt funds, and real estate funds.

   • Focus on providing capital to businesses or real estate projects without leverage.

3. Category III AIFs:

   • Employs complex strategies, such as hedge funds, long-short funds, and derivatives.

   • Focused on short-term gains through trading and arbitrage.

Example of AIF Investment

An HNI invests ₹2 crore in a Category II AIF that focuses on commercial real estate. The fund pools capital from multiple investors to invest in prime commercial properties across India.

After five years, the investment appreciates to ₹3.5 crore, generating a capital gain of ₹1.5 crore. The gains will be subject to the applicable long-term capital gains tax, as per the prevailing tax rates.

Key Components of AIFs

• Investor Base: Mainly HNIs, family offices, and institutional investors. About 60–65 percent are domestic, with 35–40 percent foreign.

• Asset Classes: Private equity, venture capital, real estate, hedge funds, and infrastructure.

  • Regulatory Framework: SEBI governs under the AIF Regulations, 2012, with amendments as of February 2025.

  • Taxation: Starting April 1, 2026, Category I and II AIFs will face a 12.5 percent tax on long-term capital gains (LTCG). This clarifies previous tax uncertainties.

• Minimum Investment: ₹1 crore, with some exceptions for accredited investors

Benefits of Investing in AIFs

• Diversification: Offers exposure to asset classes beyond traditional equities and bonds

• Higher Return Potential: Select AIFs have delivered multibagger returns (e.g., 37x, 120x) through strategic investments in emerging sectors

• Professional Management: Managed by experienced fund managers with domain expertise in niche sectors

• Regulatory Oversight: SEBI regulations ensure transparency, reducing potential fraud risks

Challenges and Considerations

• High Risk: Investments in unlisted, illiquid assets can be volatile and less predictable

• Lock-in Periods: Most AIFs have a long-term lock-in, often spanning 5 to 7 years, limiting liquidity

• Complexity: AIFs require a thorough understanding of non-traditional assets and regulatory norms

• Entry Barrier: The minimum investment of ₹1 crore limits access for retail investors. This makes AIFs better suited for experienced and wealthy investors.

Conclusion

AIFs are now popular for investors looking for diverse, high-return options beyond stocks and bonds. However, they carry higher risks, long lock-in periods, and a significant investment requirement. This makes them better suited for experienced investors who can handle risk and have a long-term view. By 2025, SEBI's updated regulations and clearer tax rules will help AIFs attract more institutional capital. They will also become easier for high-net-worth individuals to access.