An Alternative Investment Fund (AIF) is a way for investors to pool their money together and invest in non-traditional assets. These funds are usually geared toward High Net-Worth Individuals (HNIs) because they often require a larger investment upfront.
Unlike typical investments such as stocks, bonds, or cash, AIFs can include private equity, venture capital, hedge funds, commodities, art, antiques, and derivatives. They offer a chance to explore opportunities that aren’t available in regular markets.
However, alternative assets are often fairly illiquid. In comparison, it may take longer to sell a bottle of wine that is 80 years old than to sell 1,000 shares of Apple, simply because there are fewer buyers.
Despite this, AIFs provide diversification, the potential for higher returns, and access to unique investment opportunities, making them a powerful option for investors willing to plan for the long term.
Types of AIFs in India
SEBI has categorised Alternative Investment Funds into 3 categories:
Category 1:
Venture Capital Fund (VCF)
New-age startups needing substantial early-stage funding can seek out Venture Capital Funds (VCFs). These funds finance high-growth potential startups to take on financial hurdles. HNIs who invest in VCFs typically use a high-risk, high-return approach to grow their capital.
Angel Funds
These invest in budding start-ups and are angel investors. They bring early business management experience with them. These funds invest in those start-ups that do not receive funding from VCF. The minimum investment by each angel investor is Rs 25 lakh.
Infrastructure Funds
This fund invests in infrastructure companies, i.e., those involved in railway construction, port construction, etc. Investors who are bullish on infrastructure development invest their money in these funds.
Social Venture Funds
Funds investing in a socially responsible business are social venture funds. They are a kind of philanthropic investment but have a scope of generating decent returns for investors.
Category 2
Private Equity Funds
A private equity fund invests in unlisted private companies. It is difficult for unlisted companies to raise funds by issuing equity and debt instruments. Usually, these funds come with a lock-in period that ranges from 4 to 7 years.
Debt Funds
This fund primarily invests in debt securities of unlisted companies. Usually, such companies follow good corporate governance models and have high growth potential. They have a low credit rating, which makes them a risky option for conservative investors. As per SEBI guidelines, money accumulated by debt funds cannot be used to give loans.
Fund of Funds
Such funds invest in other Alternative Investment Funds. They do not have an investment portfolio but focus on investing in different AIFs.
Category 3
Private Investment in Public Equity Fund (PIPE)
A PIPE invests in shares of publicly traded companies. They acquire shares at a discounted price. Investment through a PIPE is more convenient than going for a secondary issue owing to less paperwork and administration.
Hedge Funds
Hedge funds pool money from accredited investors and institutions. These funds invest in both domestic and international debt and equity markets.
They adopt an aggressive investment strategy to generate returns for investors. However, hedge funds are expensive as fund managers can charge an asset management fee of 2% or more. They can also levy 20% of the returns generated as their fees.
Who Can Invest in an AIF?
Investors willing to diversify their portfolio can invest in AIFs if they meet the following eligibility criteria:
- Indian residents, NRIs, and foreign nationals can invest in these funds.
- The minimum investment limit is Rs. 1 crore for investors, whereas the minimum investment amount for directors, employees, and fund managers is Rs. 25 lakh.
- AIFs come with a minimum lock-in period of three years.
- The number of investors in every scheme is restricted to 1000, except angel funds, where the number of investors goes up to 49.
Benefits of Investing in AIFs
Here are some of the benefits of investing in AIFs:
High Return Potential
AIFs generally have a higher return potential than other investment options. The massive pool of money gives the fund managers enough room to prepare flexible strategies for maximising returns.
Low Volatility
AIFs have not shown direct links to stock markets. Volatility of these funds is reduced, especially in comparison to more traditional equity investments. It may, therefore, work for risk-averse investors seeking stability.
Diversification
These funds allow much-needed diversification in an investment portfolio. They act as a cushion during a time of financial crisis or market volatility.
AIFs are an interesting investment option for those investors, mostly HNIs, who aspire to receive high returns and are unwilling to take high risks.
Investors can conduct thorough market research and invest in a category of AIF based on their financial goals and risk appetite.
Conclusion
Alternative investment funds are a great option for those seeking to diversify their investments. Due to their high risk and lock-in period restrictions, they are best suited for seasoned investors. Remember to understand what alternative funds are, conduct due diligence, and evaluate the specific risks associated with AIFs before making financial decisions.
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