Explained: Alternate Investment Fund (AIF)

  AIF is an acronym for ‘Alternate Investment Fund’.

AIFs are structured as trusts, limited liability partnerships (LLPs), or companies that can be registered with SEBI. These entities are Indian investment vehicles that collect funds from sophisticated investors, whether Indian or foreign, for investing by a defined investment policy. AIFs are regulated by the Securities and Exchange Board of India (SEBI). However, AIF Funds are not subject to SEBI’s (Mutual Funds) Regulations, 1996, SEBI’s (Collective Investment Schemes) Regulations, 1999, or any other fund management regulations.

AIFs often invest in non-traditional asset classes, such as private equity, venture capital, or distressed assets. These assets can be more volatile and carry higher risks compared to traditional investments like stocks and bonds.

AIFs have three categories. The minimum investment amount for Category 1 AIF, Category 2 AIF, and Category 3 AIF is Rupees one crore, and for angel investors, the minimum investment is INR 25 lakhs.

The Category I AIF

Category I AIF:
* Venture capital funds (Including Angel Funds)
* SME Funds
* Social Venture Funds
* Infrastructure funds
Venture Capital Funds: Venture capital funds are pooled investment funds that manage the money of investors who seek private equity stakes in startups and small- to medium-sized enterprises with strong growth potential. VCFs help get them off the ground through funding and guidance, aiming to exit at a profit.

Venture capital generally comes from well-off investors, investment banks, and other financial institutions. They not only inject funds into a new firm but also provide a simultaneous input of skills needed to set the firm up, design its marketing strategy, organise and manage it. The finance is also available for high technology and funds to turn research and development into commercial production even in the pre-start stage. This type of investment capital is known as venture capital and those investors are called venture capitalists. In partnership with the entrepreneur, the venture capitalist acts as a trigger in launching new businesses and as a catalyst in stimulating existing firms to achieve optimum performance.

SME Funds: SME funds funds invest in small and medium-sized enterprises with a proven profitability and growth track record. SME funds fall under category 1 AIF (alternative investment fund). These funds require a minimum investment of Rs.1 crore and the minimum lock-in is for 3 years with an additional extension option of 2 years. In addition, to be classified as an SME AIF, they need to invest a minimum of 75% of their assets in listed or proposed-to-be-listed or unlisted SME companies. These funds generate returns when the SME is listed or when the company reports substantial growth post-funding. If the fund delivers returns over the minimum return (say 8%) then the fund management team takes a share of the excess returns.

Social Venture Fund (SVF): Social Venture Fund (SVF) investors provide risk capital and support to social enterprise businesses that aim to solve social or environmental problems in exchange for equity or a portion of the enterprises’ profits. A Social Venture Fund (SVF) is an alternate investment fund that invests 75 per cent or more of its corpus in unlisted securities or partnership interests of social ventures that satisfy social performance norms defined by the fund. The fund may accept from and give grants to social ventures and may accept restricted or muted returns.

Infrastructure Funds: Infrastructure funds invest in infrastructure projects such as airports, highways, and power plants.

Category II infrastructure Funds: SEBI clarified that a Cat II AIF can invest in debt securities in addition to equity and equity instruments of investee companies. SEBI clarified that to compute the threshold on diversification, the manager should consider 25% of the investible funds i.e. total commitment of the fund net of estimated expenditure for administration and management. As per the AIF Regulations, the manager or sponsor of a Category II AIF is required to have a minimum continuing interest in the AIF of not less than 2.5% of the fund’s corpus or INR 5 crores, whichever is lower.

Debt Funds: Debt funds invest in debt securities such as bonds, debentures, and other fixed-income instruments. SEBI clarified that a Cat II AIF can invest in debt securities in addition to equity and equity instruments of investee companies. SEBI clarified that to compute the threshold on diversification, the manager should consider 25% of the investible funds i.e. total commitment of the fund net of estimated expenditure for administration and management. As per the AIF Regulations, the manager or sponsor of a Category II AIF is required to have a minimum continuing interest in the AIF of not less than 2.5% of the fund’s corpus or INR 5 crores, whichever is lower.

The Category III AIF:

Category 3 AIFs invest in securities of listed as well as unlisted investee companies, derivatives, complex or structured products, or other AIF units. The minimum ticket size for investing in Category III AIFs is Rs 1 crore. They can be open-ended or closed-ended funds. For a closed-ended fund, the minimum tenure is three years. The minimum ticket size for investing in Category III AIFs is Rs 1 crore. This category of AIFs is permitted to take leverage positions of up to two times the total fund corpus. The income earned by this fund is subject to taxation at the AIF level and depends on the structure of incorporation of the AIF as a trust, LLP, or company.

Alternative investments under Category III can include private equity or venture capital, hedge funds, managed futures, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.

Real Estate Funds:  Real estate funds are a kind of Mutual Funds that invest in properties that are offered by Real estate companies and generate returns through rental income, capital appreciation, or both.

Private Equity Funds: Private equity funds invest in private companies and provide capital to help them grow and expand.

Hedge Funds:  Hedge funds are AIFs that employ various investment strategies, such as short selling and leverage, to generate returns for investors.

Commodity Funds: Commodity funds invest in physical commodities such as gold, silver, and oil, as well as commodity futures and options.

Private Investment in Public Equity (PIPE): In this case, the fund managers buy shares at a discount. PIPE helps small-medium-sized companies to fund their projects with ease.

Who can invest in AIFs?

As per Securities and Exchange Board of India (SEBI) regulations, only certain categories of AIF investors can invest in AIFs. These include Qualified Institutional Buyers (QIBs). The QIBs are institutional investors deemed to have the expertise and financial resources to invest in AIFs. Examples of QIBs include banks, mutual funds, insurance companies, and foreign portfolio investors.

High Net Worth Individuals (HNIs): HNIs are individuals with a net worth of at least Rs. 2 crores or an annual income of at least Rs. 1 crore. They can invest in AIFs individually or through an investment vehicle such as a family trust.

Family Offices: Family offices are investment vehicles that manage the wealth of high-net-worth families. They can invest in AIFs on behalf of their clients.

Employees and Directors of the AIF: Employees and directors of the category of AIF and their family members can invest in the fund.

Those who want to invest in alternate investments must provide proof of income, PAN card, and ID proof.

Related Post: