How does an AIF work?
Alternative Investment Funds (AIF) are privately pooled investments that collect money from sophisticated private investors. AIFs invest the money pooled from private investors according to the investment policy. They invest the money in start-ups, private equities, real estate, social venture capital funds etc.
AIFs can be established as a company, trust, limited liability partnership or a corporate body. AIFs in India have their regulation, Regulation 2 (1) (b) of the Regulation Act, 2012 of SEBI.
The minimum investment and fees in AIFs are higher than conventional investments. Valuation of an AIF is challenging as the asset classes that it invests in is pretty rare. AIFs are illiquid investments, and the transaction costs are lower, due to low turnover. All Indians, including NRIs, PIOs, and OCIs are eligible to invest in AIFs, provided they have met the eligibility criteria.
What are alternative funds?
Alternative funds are non-traditional financial assets that invest in securities such as hedge funds, art, antiques, real estate, etc. These funds may not be appropriate investment options to many investors; however, they are good options for portfolio diversification. In other words, AIF’s investments differ from conventional investment avenues such as stocks and fixed income securities (debt), etc.
Securities and Exchange Board of India (SEBI) Regulations 2(1)(b) of the Regulation Act, 2012 describes Alternative Investment Funds. AIF can be in the form of a company or trust or corporate body or a Limited Liability Partnership (LLP).
Alternative funds are a smart way to gain non-traditional investment options. However, it is wise to conduct extensive research before investing in an alternative fund. It is essential to understand if the fund fits perfectly with one’s investment objective and goal.
Mostly, high net worth individuals, institutional investors, etc., hold AIFs because of their complex nature, lack of regulation and level of risk. Some of the alternative investment options are hedge funds, private equity or venture capital, art, antiques, derivatives and commodities.
Alternative Investment Funds have the following three categories:
- Category I: Invests in SMEs, start-ups and in projects that are socially and economically viable. For example, venture capital fund, angel fund, infrastructure fund, and social venture fund.
- Category II: Invests in equity and debt securities. For example, private equity funds, debt funds, and funds of funds.
- Category III: Invests in funds that aim short term returns by employing complex trading strategies. For example, hedge funds, private investment in a public equity fund.
Are alternative investments high risk?
Any investment involves an element of risk, so do alternative investments. Alternative Investment Funds invest in pretty rare asset classes. Hence the liquidity is low making it difficult for investors to find an exit price. Along with liquidity risk, the volatility in these funds is also high. The returns from alternative investments are pretty high, which implies considerably more risk.
What are the benefits of alternative investments?
Alternative investments are not listed on the stock exchange, unlike traditional investments. This provides diversification to an investor’s portfolio. Additionally, the tax benefits that alternative investments offer differ from conventional investments. This increases the scope of getting multiple tax benefits. Also, they offer higher returns when compared to traditional investments. Following are the benefits:
- Diversification: AIFs invest in private equities, venture capital, real estate, start-ups, and other asset classes that are not traditional assets classes. Hence private investors looking for diversification can invest in AIFs.
- Tax benefits: Investments come with taxation. However, to encourage individuals to invest, the government has introduced various tax benefits. Alternative investments have tax benefits that may be different from traditional investments.
- High returns: High returns always compensate for high risk. AIFs offer higher returns than traditional investments.
What is an alternative investment vehicle?
Alternative Investment Vehicle (AIV) is a separate entity from the main fund. Some portion of the investor’s capital is invested in the AIV. And the AIV makes some of the investments made by the fund. The main purpose of an AIV is when it is difficult to make a particular investment through the main fund vehicle due to regulatory or tax disadvantages. Or to enable investors to invest in particular investments through intermediate entities to satisfy their own regulatory or tax issues.
There are two broad categories of AIVs:
Subsidiary AIV: The fund directly owns it. The ownership is either in whole or in part with other investors. Also, the subsidiary AIV in turn, holds the portfolio investment.
Parallel AIV: The fund does not own it. However, it is a subset of the fund’s partners, including its general partner. The parallel AIV invests in the portfolio company together with the fund, that also holds a direct investment in the portfolio company.
Frequently Asked Questions
Who regulates AIF?
The Securities and Exchange Board of India (SEBI) regulates Alternative Investment Funds (AIF) in India. These regulations were introduced in 2012 and hence are called SEBI AIF regulations 2012.
What is the minimum investment amount required to invest in an AIF?
The minimum amount of investment for angel funds is INR 25 lakhs per investor. If the AIF isn’t an angel fund, the minimum amount of investment is INR 1 crore per investor.
Are AIFs open-ended, i.e., open to subscription for the overall tenure of the fund?
Category I AIF and Category II AIF are close-ended funds with a minimum tenure of three years. However, Category III AIFs have an option to be open-ended funds. Suppose a Category III AIF is an open-ended fund. In that case, an investor can subscribe to it anytime during the tenure of the fund.