Alternative Investment Funds, or AIFs, are designed for investors who are looking beyond traditional investment options. They can invest in areas such as private companies, real estate, venture capital, private credit and other alternative assets.
But like any investment, an AIF can also underperform.
The value of its investments may not grow as expected, a portfolio company may face difficulties, an investment may take longer to exit, or market conditions may affect the fund’s overall performance. When this happens, investors naturally want to know what they can do.
Understanding what happens when an AIF underperforms is important because an investor’s options can depend on the fund structure, its documents, the reason for the underperformance and the stage of the investment.
What Does It Mean When an AIF Underperforms?
An AIF underperforms when its actual performance falls short of the return that investors or the fund manager had expected or that a relevant benchmark may indicate.
This does not always mean that the fund has permanently lost money.
AIF investments can have long investment horizons, particularly when the fund invests in private companies, real estate or other assets that may take time to mature. There can be periods when the portfolio does not perform well, followed by improvement later.
For example, a private equity fund may invest in a company expecting it to grow over several years. If the company’s growth is slower than expected, the fund’s returns may also be delayed.
Similarly, a private credit fund may face a situation where a borrower has difficulty making payments. The fund manager may then need to take steps to protect the investment and recover the money.
Therefore, the first step is to understand why the AIF is underperforming.
Why Can an AIF Underperform?
There can be several reasons.
Market conditions are one possibility. Changes in interest rates, economic growth, industry conditions or investor sentiment can affect the value of investments held by an AIF.
The underlying investments themselves may also face problems. A portfolio company may not grow as expected, a real estate project may be delayed, or a borrower may face financial difficulties.
The fund’s investment strategy can also affect performance. Some strategies naturally take longer to generate returns. An AIF investing in early-stage companies, for example, may have to wait several years before an investment produces a meaningful exit.
There can also be situations where the fund manager’s original investment assumptions do not work out.
Understanding the reason matters because the appropriate response can be very different in each situation.
Do Investors Get Their Money Back Immediately?
Not necessarily.
This is an important difference between AIFs and more easily redeemable investments.
Many AIFs have a defined investment period and may not allow investors to withdraw their money whenever they want. The exact terms depend on the fund’s structure and governing documents.
For instance, a Category II AIF may have investments that are intended to be held for several years before an exit. Even if the fund temporarily underperforms, an investor may not have an immediate redemption option.
This is why investors should understand the fund’s tenure, lock-in or exit provisions and other terms before investing.
Can an Investor Exit the AIF?
The answer depends on the specific AIF and its documents.
Some funds may provide mechanisms for transferring an investor’s interest, subject to applicable conditions and approvals. However, finding a buyer for an interest in an AIF may not always be straightforward.
An investor may also have to consider whether exiting at that point makes financial sense. If the underlying investments are temporarily underperforming but have the potential to recover, exiting may produce a different outcome from remaining invested until the fund completes its investment strategy.
This is why an investor should first understand the available exit mechanisms rather than assuming that an AIF works like a mutual fund where units can generally be redeemed based on the applicable scheme terms.
What Should Investors Look at First?
When an AIF underperforms, investors should start by reviewing the fund’s documents and latest communications.
The private placement memorandum, contribution agreement and other fund documents can explain how the fund operates, how investments are valued, what fees are charged, how distributions work and what rights investors have.
Investors should also look at the latest reports provided by the fund.
The objective is to understand whether the underperformance is temporary, whether there has been a change in the fund’s strategy and whether the underlying investments are still progressing according to the original plan.
Look Beyond the Return Number
A single return figure does not always tell the complete story.
For an AIF, investors may need to look at the portfolio itself.
What companies or assets does the fund currently hold? How have those investments performed? How much capital has been deployed? How much remains to be invested? Are there investments that are expected to be exited soon?
These questions can provide more context around the fund’s current position.
For example, an AIF could report modest returns during an early stage because the fund has invested capital but has not yet realised gains from its investments. That situation is different from a fund whose underlying investments are experiencing serious and continuing problems.
Understand the Fund Manager’s Response
When an AIF underperforms, the fund manager’s actions are also important to understand.
Depending on the situation, the manager may change the investment strategy, provide additional support to portfolio companies, restructure an investment, negotiate with borrowers or look for alternative exit opportunities.
Investors should understand what the fund manager believes caused the underperformance and what actions are being taken in response.
This does not guarantee that performance will improve. It simply gives investors a clearer picture of how the fund is responding to the situation.
What If the Fund Manager Has Not Followed the Fund’s Stated Strategy?
This is a different situation from simply having poor investment performance.
An investment can underperform even when the fund manager has followed the stated strategy and acted within the fund’s documents.
However, if investors believe there has been a breach of the fund’s governing documents, a failure to follow applicable requirements or another issue involving the management of the fund, they may have additional avenues available to them.
The first step is to examine the relevant documents and raise the matter with the appropriate fund or manager contact.
If the issue cannot be resolved, investors can consider seeking independent legal or professional advice about the remedies available to them.
What Role Does SEBI Play?
AIFs in India are regulated by the Securities and Exchange Board of India, or SEBI.
SEBI’s regulatory framework covers areas such as the registration and operation of AIFs, disclosures, investment conditions and other requirements.
However, regulation does not mean that an AIF is guaranteed to generate returns.
Investment risk remains with investors, and an AIF can lose value or generate lower returns than expected.
Investors should therefore distinguish between investment underperformance and a potential regulatory or compliance issue. They are not the same thing.
Can Investors Raise a Complaint?
If an investor has a grievance relating to an AIF or its intermediary, the first step is generally to approach the concerned entity and attempt to resolve the issue.
If the matter remains unresolved, investors can explore the applicable grievance redressal mechanisms available through SEBI and the relevant intermediary.
However, a complaint mechanism should not be viewed as a way of recovering losses simply because an investment performed poorly.
Market losses and regulatory grievances are different matters.
Should You Stay Invested or Exit?
This is one of the most difficult questions for an investor.
There is no universal answer because the decision depends on the specific fund, the remaining investment period, the underlying portfolio and the investor’s own financial situation.
An investor should first understand whether the fund’s underperformance is temporary or linked to deeper problems. It is also important to check whether an exit is actually available under the fund documents and what financial consequences could arise from exiting.
Rather than making a decision based only on a disappointing return figure, investors can review the fund’s latest performance, portfolio updates, valuation information, remaining tenure and the manager’s plan.
Independent financial or legal advice may also be appropriate, particularly when a significant amount of capital is involved.
What Investors Can Learn From an Underperforming AIF
An underperforming AIF can also highlight why due diligence matters before investing.
Investors should understand the fund’s investment strategy, risk factors, expected holding period, fee structure, manager’s experience, portfolio construction and exit strategy before committing capital.
It is equally important to understand that alternative investments can involve limited liquidity and higher levels of risk compared with some traditional investments.
The goal of due diligence is not to eliminate risk. That is not possible.
Instead, it helps investors understand what risks they are taking and whether those risks fit their investment objectives and time horizon.
The Bottom Line
An underperforming AIF does not automatically mean that an investor has no options.
The available options can include reviewing the fund’s disclosures, understanding the reasons behind the performance, communicating with the fund manager, checking the applicable exit or transfer provisions and, where appropriate, using formal grievance mechanisms or seeking independent professional advice.
At the same time, investors should remember that poor investment performance by itself is not necessarily evidence of misconduct or a regulatory violation.
The most important thing is to understand the difference between normal investment risk, temporary underperformance and potential issues with how the fund has been managed.
For investors in AIFs, knowing what to check, what questions to ask and what rights are provided under the fund documents can be just as important as understanding the potential returns.
