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When it comes to investing, traditional investors tend to choose low-risk and high-return yielding tools. Most prefer to invest in debt mutual funds. They choose instruments that can keep the principal amount invested safe and at the same time provide good returns.
For non-traditional investors, this aspect of investing varies. When you talk about non-traditional investors, this also includes High Net-worth Individuals (HNI). These HNI’s look to invest for the long term while looking to diversify their portfolio.
For such investors, there is another way to invest by choosing Alternative Investment Funds (AIF).
What is an Alternative Investment Fund (AIF)
Investors, traditional as well as non-traditional, choose to invest in mutual funds. This includes a variety of stocks and debt options. Each instrument comes with its own risks and rewards. Depending on the type and category of the mutual fund, SEBI has laid down a set of rules and regulations. As per the rules, mutual funds need to invest a bulk of the corpus as per the category they belong to, along with multiple other rules, that allow for liquidity, withdrawal, closure, etc.
However, Alternative Investment Funds are categorized separately by SEBI guidelines and unlike regular debt or equity mutual funds. So, what is the meaning of Alternative Investment Funds?
SEBI defines AIF as any fund that has been incorporated or established in India, which is a privately pooled investment instrument. These privately pooled funds can invest in real estate, hedge funds, or private equity. It can also be in the form of a Limited Liability Partnership (LLP), trust, or a corporate body.
SEBI also explains that AIF collects funds from investors who can be Indian or foreign nationals for investing in it as per a defined policy, which has to benefit its investors.
Alternate Investment Fund is essentially private funds. These funds are generally not open to the general public or available as easily as most mutual funds are to investors. According to SEBI, “AIF does not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities.”
Types of Alternative Investment Fund (AIF)
As per SEBI’s regulations, there are three types of Alternative Investment Funds:
Category I AIF: Alternative Investment Funds that primarily invest in early stages ventures, Small and Medium Enterprises, social ventures that fall under Category I AIF. Socially and economically viable projects, as considered by the Government of India, also fall under this category.
For HNI’s looking to invest in Category I AIF, there is 4 type of funds that can be a suitable choice:
- Venture Capital Funds: These funds invest in start-ups that can have a potential for high growth.
- Angel Funds: They are a subcategory of Venture Capital Funds and invest in start-ups. They bring in not just the money but also business experience to guide start-ups.
- Infrastructure Funds: Funds that invest in the development of infrastructures like airports, roads, and railways are termed Infrastructure Funds.
- Social Venture Funds: These funds invest in companies that look to generate good returns while solving social and environmental issues.
- SME Funds: These funds invest in small to medium enterprises.
Category II AIF: Category II type of Alternative Investment Funds does not follow the same route as Category I and Category III. The purpose of Category II AIF is to help companies, business ventures looking for funds that are required for daily operations.
Various types of funds under this category include private equity funds, real estate funds, funds for distressed assets. These AIFs, however, do not receive any specific concession or incentive by the government or any regulator.
Category III AIF: This type of Alternative Investment Fund invests in Private Investment in Public Equity (PIPE) funds, hedge funds, and funds that trade to gain short-term returns or any open-ended funds. Like Category II Type of Alternative Investment Fund, these funds also do not receive any concession or incentive by the Government of India.
Fees and Tenure for AIFs
The minimum investment for AIF in all three categories is between INR 1 Crore. Application and registration fees are applicable at a fund level and will be thus passed on to investors of the fund accordingly.
While application fees are INR 1 Lakh, the registration fees vary. For Category I Type of alternative investment, registration is INR 5 Lakhs, for Category II it is INR 10 Lakh and for Category III the registration fees are INR 15 Lakh.
Category I and Category II types of Alternative Investment Fund are close-ended funds. Category III type of alternative investment can be either close-ended or open-ended. There is no fixed tenure for closure and is decided at the time of application. The minimum tenure for investments in three years.
For investors looking for an extension of close-ended schemes under Category I AIF and Category II type of AIF, they can get an extension for up to 2 years. However, this is only possible on approval of two-thirds of the unitholders, by the value of their investment. If the majority refuses to consent to the extension, The AIF will need to fully liquidate within one year from the expiration of the fund’s actual or extended tenure.
Difference Between Mutual Fund and Alternative Investment Fund
There are many forms of investing. Mutual funds, portfolio management services, and Alternative Investment Funds form a part of services that investors can avail of. When you further bifurcate these segments, you get multiple tools of investment. Though it may seem similar at a first glance, they vary in terms of minimum investment required, types of tools, etc.
| Mutual Funds | Alternative Investment Funds | |
| Definition | A professionally managed investment scheme that collects funds from investors who share a common investment goal is defined as mutual funds. | Privately pooled investments that collect funds from Indian or foreign investors for investing in agreement with a defined investment policy that would benefit its investors. |
| Tools | Stock and Debt Options | Venture Funds, SME Funds, Infrastructure Funds, Social Venture Funds |
| Types | Equity Funds Hybrid FundsDebt FundsIncome or Debt Funds Solution-Oriented Funds | There are Three Types: Category I Category II Category III |
| Minimum Investment | Minimum Investment can be as low as INR 500 | The minimum investment required is INR 1 Crore |
| Investor Type | Mutual Funds work for every type of investor who wants to create a safe financial future | Alternative Investment Funds work well for HNIs who are looking to diversify their portfolio and can remain invested for a long period of time |
| Risks | Depending on the type of fund invested in, credit risk varies. However, when compared to AIF or PMS, the risk is lower | Risk on Alternative Investment Funds is higher as compared to MFs. |
| Returns | Depending on the type of fund invested in, returns can range from low to high | AIFs tend to give higher returns as compared to MFs. |
| Liquidity | Solution-oriented schemes have a maximum lock-in period of 5 years, ELSS have a minimum lock-in period of 3 years and term based mutual funds do not have a lock-in period | Category I and Category II have a minimum lock-in period of 3 years. Category III does not have a lock-in period. |
| Taxation | Under Section 80C, you can claim a tax benefit of INR 1,50,000/-. On profits or gains received, depending on the tenure of the funds, Capital Gain Tax is applicable. | Profits received under Category I and Category II are taxed. Income generated on Category III is taxed at 42.7% |
Taxation on Alternative Investment Funds
The taxation rule for all three categories varies.
Category I and Category II Alternative Investment Funds have pass-through tax status. A pass-through status is when the business takes away any obligation to pay corporate tax. The tax is only paid by the investor.
When you receive the income from your Category I and Category II AIF, the tax on the same will be paid by the investor and not the fund business. Business income, which is the income earned by the operations of the business is not taxed. It is the income or the loss that falls under the tax purview.
The duration of the investment is important for tax calculations on AIF. For profits on short-term investments which are held for a period of fewer than three years attract short-term capital gain tax. The rate of STCG tax is 15%.
When the duration stretches beyond three years, the profits attract long-term capital gain tax. Long term capital gain tax of 10% is applicable after a period of three years along with applicable STT.
Investors who have invested equity AIF can claim benefits of indexation as well. This is taxed at a rate of 20% and the investor can compute the tax amount after the amount to be paid after calculating the indexation amount.
Category III type of Alternative Investment Fund has its own taxations. It does not have a pass-through status. This means that the business and the investor will have to pay tax on the profits made by the fund.
Apart from short-term capital gain tax, long term capital gain tax, Category III also has to pay dividend tax as well as Business Income tax. They fall under the highest tax bracket of 42.7%.
Conclusion
According to SEBI, Alternative Investment Fund is for sophisticated investors. The risk involved is considered to be fairly high in these funds. However, when invested for a long period of time, the returns can also be higher. There is flexibility, in terms of strategies, timing, hedging of derivatives, etc. when it comes to investing in AIFs.
Alternative Investment Funds can be a viable option for investors who are well aware of the risks and rewards and are investing in tools other than debt and stock options.
Frequently Asked Questions (FAQs)
1. Why should you Invest in an AIF?
AIFs are different from traditional means of investing. For investors looking to diversify their portfolios, AIFs can be a good option for investment. The performance is not correlated to the market. However, while the returns are high, so are the risks.
2. Who is Eligible to Invest in AIF?
Indian, as well as foreign nationals, can invest in AIFs.
3. What is the Minimum Investment Amount Required to Invest in an AIF?
The minimum investment required to invest in AIF is INR 1 Crore.
4. How to Invest in Alternative Investment Funds in India?
Any investor can enjoy the benefits of investing through Nivesh in the following easy steps:
- Create an account in Nivesh by providing your basic details. (If you already have an account then just login into your account)
- On your portfolio page click on the Buy New tab at the right top corner of the screen.
- Select AIF and choose the scheme you want to purchase.
- Your request will be generated and a relationship manager will get in touch with you for getting the investment done.
