Many investors, particularly HNIs, seek other investment opportunities besides stocks and bonds. An Alternative Investment Fund (AIF) is one choice they should consider. In comparison to conventional investments, these options may offer better returns, though they generally pose a greater risk than equities. The funds are aimed at HNIs, but ordinary midsize investors are also anticipated to have access to them.
The Indian AIF market was worth Rs 6.4 lakh crore as of March 31, 2022, a remarkable 7X increase over the previous five years. It demonstrates that investors have a lot of interest in India.
What is an AIF?
The phrase “Alternative Investment Fund” describes a group of pooled investment funds that invest in venture capital, private equity, hedge funds and other investments. A firm or a Limited Liability Partnership (LLP) can set up an Alternative Investment Fund.
According to the Securities and Exchange Board of India (SEBI), AIFs are divided into three categories:
- Category 1: invests in SMEs, startups and new, commercially viable businesses with significant room for expansion. This includes infrastructure funds, venture capital funds (VCF), angel funds (each angel investor contributes at least Rs 25 lakh) and social venture funds, which invest in companies that aim to influence society.
- Category 2: funds that only use leverage to meet operational needs. This includes debt funds, which invest in the debt securities of unlisted businesses with strong development potential and sound governance, funds of funds, and private equity funds, which invest in unlisted businesses through debt and equity instruments.
- Category 3: funds that use a variety of sophisticated trading strategies, such as buying listed or unlisted derivatives. This includes hedge funds, which pool money from investors and businesses to invest in domestic and international debt and stock markets, and PIPE funds, which buy stock in publicly traded companies at a discount.
Who may invest in AIFs?
- AIFs are open to investments from Indian residents, NRIs and foreigners.
- The minimum investment is Rs 1 crore. The minimum for directors, employees and fund managers is Rs 25 lakh.
- The typical lock-in period is three years. A maximum of 1,000 investors may participate in each scheme, and 49 in angel funds.
Why should I invest in AIFs?
- Diversification: essential for every investor, and even more so for HNIs with large ticket sizes. AIFs act as a cushion when the market is volatile.
- High returns: the large amount of pooled capital enables fund managers to plan flexible strategies for maximising returns.
- Low volatility: AIFs are not tied to the stock market, so they can be less volatile than typical equity investments, although risks are still involved.
The tax advantages of AIFs
AIF taxation varies with the type of fund. Categories 1 and 2 have pass-through status, which means the investor, not the fund, is responsible for paying tax on the income (or loss) generated by the fund. In brief, you pay capital gains tax on profits earned under these two categories. Different rates are payable for Category 3, depending on the nature of the profit.
Conclusion
For investors seeking high returns with a certain degree of risk, AIFs are an interesting choice. Investors must nonetheless properly understand the fund and be aware of the risk before investing. Since AIFs are anticipated to open to retail investors in the coming years, small retail investors can continue to learn about this option.