What are Alternative Investment Funds in India?

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Synopsis:

Alternative Investment Funds invest in non-conventional or alternative assets, for instance, private equity and hedge funds. Such funds offer investors a chance to earn potentially high returns and diversify their portfolios. In this article, let us explore the concept, workings, benefits, and types of Alternative Investment Funds in India.

In today’s time, investors have access to various types of investing avenues spanning across industries, asset classes, and risk profiles. Although conventional market-linked investment vehicles such as equity, debt, and derivatives remain popular choices, the past few years have seen the rise in prominence of another type of investment tool, namely Alternative Investment Funds or AIFs. In this article, we shall shed light on

  • Meaning of Alternative Investment Funds
  • Types of Alternative Investment Funds in India
  • Eligibility criteria to invest in an AIF in India
  • Key benefits of investing in Alternative Investment Funds
  • How are AIFs taxed in India

What are Alternative Investment Funds

As their name suggests, Alternative Investment Funds (AIFs) invest in alternative assets. Such assets include private equity, social ventures, hedge funds, infrastructure funds, and SME funds, to name a few. AIFs in India carry a minimum investment threshold of Rs. 1 crore for investors and Rs. 25 lakhs for fund managers.

Although the tenure of each Alternative Investment Fund is different, a majority of such funds carry a lock-in period of three years or more. All AIFs in India are registered with and regulated by the Securities and Exchange Board of India (SEBI). According to SEBI regulations, an Alternative Investment Fund in India can take the form of

  • Company
  • Trust
  • Corporate entity
  • Limited Liability Partnership

Types of Alternative Investment Funds in India

Alternative Investment Funds in India have been bifurcated into three major categories, with each comprising varying types of AIFs.

Category I Alternative Investment Funds

  • Venture Capital Funds: This type of Alternative Investment Funds targets start-ups, particularly in early stages of their operations. Since it is often difficult to source capital at the nascent stages of a venture, such funds have no dearth of start-ups to choose from.
  • Infrastructure Funds: The investment avenues for this type of Alternative Investment Funds include huge infrastructure projects, ranging from road construction to railways.
  • Social Venture Funds: As their name suggests, this type of Alternative Investment Funds invests in entities which are dedicated to social causes. Such causes can be diverse and include environmental protection, generation of renewable energy, and education for underprivileged children.
  • Small and Medium Enterprises Funds (SME Funds): This type of AIF invests in small and medium enterprises which are characterised by strong fundamentals, market standing, and high potential for future growth.

Category II Alternative Investment Funds in India

  • Debt Funds: The investment target for this type of Alternative Investment Funds is the debt securities of unlisted companies. While the company gets access to the required capital, the fund benefits from the fixed income of the debt instruments.
  • Private Equity Funds: When a company is not yet listed on a stock exchange, its sources of raising capital, particularly after the initial investments by promoters, are quite limited. Private Equity Funds are a type of Alternative Investment Funds that invest in such companies and help them fulfill their capital gaps.
  • Fund of funds: This type of Alternative Investment Funds invests in a wide array of AIFs, thereby providing the fund's investors with a diversified risk and return spread.

Category III Alternative Investment Funds in India

  • Private Investment in Public Equity Fund: Listed companies may also reach a point when they find it difficult to raise further capital. This happens when the company's share prices and market perception significantly decline. In such a scenario, a Private Investment in Public Equity Fund or PIPE can be an effective source of capital for said company. Owing to the relatively weak market position of the company, the equity thus raised is often at a discounted rate as compared to the prevailing market price.
  • Hedge Funds: This type of Alternative Investment Fund invests in a variety of assets and deploys complex trading strategies such as short selling. The main target of such a fund is to limit the risk exposure of the investors and increase their return on the fund.

Eligibility criteria to invest in an Alternative Investment Fund in India

Now that we have discussed the meaning of Alternative Investment Funds and their types in India, let us turn our focus toward the eligibility criteria to invest in such funds. All resident Indians can invest in AIFs. Furthermore, Non-resident Indians and citizens of other nations can also invest in AIFs in India. There is also an option of joint investment in AIFs by the parents, spouses, and children of the fund's investors.

Benefits of Alternative Investment Funds

Investments in Alternative Investment Funds entail a host of benefits, prominent amongst which are as follows:

  • Relatively low volatility: When you invest in an Alternative Investment Fund, you can expect lower volatility than that of market-linked instruments such as equity, debt, equity funds, and index funds.
  • High return potential: Investments in Alternative Investment Funds carry a potential for high returns owing to the wide range of sectors and asset classes such funds invest in.
  • High yet diversified risk: Investing in AIFs is an effective way to diversify your investment portfolio and spread the overall risk across various sectors and assets.

How are Alternative Investment Funds taxed in India

The taxability for AIFs in India is contingent upon the category of the fund. While all income generated from category I and category II AIFs (barring business income) is exempt from income tax in the hands of the AIF. The tax liability is imposed on the investor instead. In stark contrast, the income of category III AIFs is taxable in the hands of the fund, with no tax liability for the investors’ gains.

To sum it up

Alternative Investment Funds are considered to be complex investment vehicles that carry high risk and reward potential. AIFs invest in non-conventional asset classes and a variety of entities and sectors, including start-ups and social initiatives. As such, investments in AIFs should be undertaken with acute understanding of the instrument and their investment targets and strategies.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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