The concept of alternative funds may have seemed to cater to the investment needs of only large institutional investors, given the relative complexity in the concept and working of these funds.
However recent changes have opened up this investment option to a larger segment of the society. This is because, though these alternative investment funds were introduced in India only in 2021, they saw a huge influx of demand as the benefits associated with various types of alternative investment funds are more advantageous than one can expect.
The year on year increase in the principal fundraised as depicted in the table below is a clear indication of the gaining popularity of AIFs. (data source: SEBI)
September 2018 September 2019 September 2020
INR 115564. 58 crores INR 154762. 286 crores INR 197159.7 crores

 

 

This alternative investment platform includes funds from angel investors, hedge funds, private equity, venture capital among others. These funds are not covered by the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities.

Subject to meeting gate criterion; all Indian citizens, Non-Resident Indians (NRIs), Persons of Indian Origin (PIOs) and Overseas Citizens of India (OCI) can choose to invest in Alternative Investment Funds.

 

 

What are Alternative Investment Funds?

 

It is a fact that investment in AIF or Alternative Investment Funds differs from those in conventional investment tools or options like our stocks, bonds and debt market instruments.

AIF consists of a fund incorporated by privately pooled investment vehicles that gathers funds from sophisticated HNI investors. In order to benefit its investors, these investments are governed by a defined investment policy of AIF but are not guided by principles of SEBI regulations or other regulations of the Board to regulate fund management activities.

Regulation 2 (1) (b) of the Regulation Act, 2012 of SEBI regulates investments in AIF. An Indian AIF may be formed as a trust, a company, Limited Liability Partnership (LLP) or a corporate body. Trust is the most common form in which AIFs are registered.

SEBI classified Alternative Investment Funds under three fundamental categories based on the types of investments they encompass – viz. Category I AIF, Category II AIF and Category III AIF. As mentioned earlier, they entail angel funds, private equity, hedge funds, venture capital, etc.

It is to be noted that any AIF generally does not permit more than 1000 investors. Thus the investment fees and minimum investments required in each of the funds are higher than any conventional investment platforms.

However, transaction costs in alternative investments platforms are lower as turnover is lower compared to traditional options. Liquidity options are less in AIFs and information relating to these funds is not available publicly most of the time.

Here’s everything you need to know about alternative investment funds 

 

Who can Invest in Alternative Funds?

A sophisticated investor who is looking for diversifying his/ her risk in various asset portfolios and willing to take the inherent/ underlying risk involved in these unlisted and illiquid securities is an ideal investor for an Alternative Investments Company.

Usually, Foreigners, resident Indians, PIOs, OICs and NRIs are eligible to invest in various types of alternate investments.

Permissible limits to invest in alternative investment funds are defined as below –

 

Investor type Permissible limit in INR
General investors Maximum 1 crore
Angel investors Minimum 25 lakhs
Senior Management (like directors, VPs, fund managers) Minimum 25 lakhs

 

 

Maximum numbers of investors allowed are –

  • for AIF – 1000 investors (if the AIF is formed as a company under Companies Act, 1956)
  • for angel fund – 49 angel investors

Since funds are raised only through private placements by sophisticated investors, and AIF cannot go for large public subscription under any circumstance.

 

Minimum fund corpus mandated by SEBI is –

  • for AIFs – at least INR 20 crores
  • for angel fund – INR 10 crores

 

Alternative investment strategy allows funds for any AIF to be raised by private placements from High Net-worth Investors.

 

Following are the steps to AIF listing in Stock Exchange:

1) A placement memorandum is required to be filed with SEBI to launch a scheme under the alternate investment platform. INR 1 lakh is to be paid as a scheme fee while placing the memorandum. This is to be done at least 30 days before the launch of the scheme. However, angel fund investors are exempt from this payment for the first time they launch schemes under AIF.

2) It takes 21 days for the application to be evaluated by SEBI and update investor on the status on the success rate of the application.

3) Once registered, an amount of INR 5 lakhs is to be submitted as registration fee for the fund to be classified as an AIF in India.

4) Then the Alternate Investment Fund connects with stock exchanges in order to list the following defined norms with an agreement for investment management.

The necessary documents are –

  • Custodian agreement,
  • Draft information or a placement memorandum,
  • Trust deed,
  • MOA and AOA i.e. Memorandum of Association and Articles of Association of the issuer
  • A written undertaking from the Compliance Officer or the CEO that the particular AIF is in accordance with the SEBI(AIF) Regulations, 2012.

 

An investor requires his/ her income proof, ID proof and the PAN card to be able to invest in an AIF or Alternative Investment platform.

 

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Categories of Alternative Investment Funds (AIFs)

There are 3 distinctive categories in which SEBI has classified the Alternative Investment Funds –

1) Category I AIF.
2) Category II AIF and
3) Category III AIF

 

Each of Category I and II AIFs is needed to be closed-ended schemes with a minimum tenure of 3 years. Category III AIFs, however, may be open or closed-ended as desired. [Ref. Regulation 13(1) and 13 (3)]

Each category has to have a minimum investment of INR 20 crores. However, Angel Fund (a subcategory of AIF I) can also have INR 10 crores as its fund. Investors have a choice to invest in any of the 3 categories or sub-categories as found below.

Category I AIF comprises of:

  • Venture Capital funds (including Angel funds)
  • SME funds
  • Social venture capital funds
  • Infrastructure funds

Simply put, AIFs that invest in start-ups or early-stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as economically or socially advantageous and shall include in this category of alternate funds.

 

Category II AIF:

Category II AIFs include all those alternate funds that do not fall in Category I and III. They do not assume leverage and/ or borrowing except to meet regular operational requirements and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012. [Ref. Regulation 3(4)(b)]

PE Funds, REIT or Real Estate funds, funds from distressed assets among others are registered under Category II AIF.

 

Category III AIF:

Funds like hedge funds, PIPE funds, etc, comprise of Category III AIFs.

The alternate investment strategy employed in this alternate fund involves complex trading strategies and is likely to employ leverage including through investments in listed or unlisted derivates as well. [Ref. Regulation 3(4)(c)]

Given the above, it is the hedge funds, private equity, venture capital, real estate and, oil and gas where most of the alternative investments are made. However, some are likely to invest even in art & antiques, collectables and, gems and precious metals.

Here’s a complete guide on how to invest in alternative investments funds

 

Let us understand the most common alternative investments:

1) Hedge Funds:

In hedge funds investments are mostly done into the array of securities and are limited generally to publicly traded instruments. The alternate investment strategies undertaken are many, as the aim of the fund managers here is to generate returns in both bull and bear market conditions.

 

2) Venture Capital:

Wealthy investors prefer to invest their funds into promising start-up companies that are privately owned and have potential long-term growth prospects. These companies are generally in their early stage of growth or even at the start-up stage; but have an aim to grow rapidly and eventually go for BOT (build operate and transfer) either through merger, acquisition or IPO (initial public offer) offering.

 

3) Private Equity:

Perhaps the biggest bands of investments fall under private equity where all private investments other than venture capital are encapsulated. PE fund is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies, resulting in the delisting of public equity.

While there are many benefits investing in hedge funds and venture capital investments that attract alternate fund investors, the majority of investors enjoy the advantages they get by investing in private equity alternatives as that is where the gap lay.

 

 

Advantages of Investing in Alternative Funds

 

1) Generally do not correlate to the stock market:

Any investor who has been in the stock markets for some time is sure to have made some big wins and major losses as well. While gains made them feel great, the losses have surely caused heartburn.

Thus such investors, who have been in the stock market and are nearing retirement or aims to take retirement shortly, can look at alternative funds as a great way to diversify their portfolios to mitigate volatility in the markets.

Just as in any investments in the market, investments in AIFs too are subject to volatility but the potential to make higher returns in traditional market instruments via inflation hedging mechanism and robust diversification.

Being uncorrelated to the stock market, it makes investments in privately held AIFs less reactive to market ups and downs. For example, let us see and investment in a mortgaged property or rental property.

Even though the market may have been extremely volatile over the past one year, the borrower or the tenant would have been making their loan repayments or rent as usual in most cases.

 

2) Investments are subject to less volatility:

any investments made in equity or bond markets, are subject to market fluctuations and that makes investments risky for investors, especially the short term ones.

These fluctuations can be as a result of an array of factors and need not necessarily be connected directly to the real asset in question. Since shares of AIFs are not traded publicly in the traditional stock markets, they remain guarded against the volatility of traditional public investments.

Moreover, one’s investments in the alternate funds are typically backed by real assets.
While some may argue that if one would remain invested in the stock market for a long time, say, 8 to 10 years, the investor is likely to overcome the volatility and still gets an average of about 8 – 10 per cent return. But what they need to understand that the volatility mars the power of compounding.

As a result in private alternative investments platform, the effect of the power of compounding is much higher compared to traditional markets.

 

3) Ownership:

If you are investing in direct equity of any company in the traditional stock market, what you are entitled to be a paper asset as a very small/ nominal owner to the said properties of the company.

There is no question of having your name imprinted in the any of the assets of the company you invest in.

However in case of AIFs, given the number of maximum investors are limited, your investments are totally not gone for loss in case an AIF were to disappear.

That is because; the investors would retain their ownership in the mortgage and the rights as a lender to the business/ property.

 

4) Passive Investments:

Time is money for the HNI investors who pool funds various types of alternative investments. It is true that they generally may have funds that lay idle and they would be keen to find avenues to increase their wealth too.

Investing in stock markets or multiple homes or other tangible assets may not always be a feasible option as that demands a lot of their attention and time which is an expensive ask for such set of personnel.

Alternative investment companies have posed them with a great option for investment in real assets for medium to long term that comes with less volatility and high returns subject to underlying risk for a seasoned educated investor.

 

5) Tax norms:

Tax norms for alternative investment funds vary for each category. Let us take understand the taxability for each category –
AIF Category I and II are pass-through instruments. The AIFs do not need to bear any tax on their earnings.

The earnings are taxable in the hands of the investors who need to pay a tax per their tax slabs. In case there have been capital gains on the shares, then it entails 10% or 15% tax based on the holding periods.

AIF Category III on the other hand is taxed at the highest income tax slab level at 42.7%. However, this happens at the fund level itself. The investor receives the returns post-tax deducted by the fund itself.

 

6) Redressal of complaints:

SEBI has set up a web-based central grievance redressal system by the name of SEBI Complaint Redress System (SCORES) at http://scores.gov.in for investors to lodge their complaints, if any, against AIFs.

Further for dispute resolution, the AIF Regulations calls for each AIF by itself or by the Sponsor or Manager, is required to formulate and roll out procedures for dispute resolutions for investors, AIFs, Sponsors or Managers via arbitration or similar machinery as mutually arrived and agreed between investors and the Alternative Investment Fund.

All of the above and more have resulted in the increasing popularity of investments in alternative investment funds. So the educated HNI investors, who are willing to invest in unlisted and illiquid securities to absorb the underlying risk, find AIFs a viable and attractive vehicle to diversify the risk of their investment portfolios.

 

Start Investing in Alternative Investment Funds Today!

 

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