All you need to know about Alternative Investment Funds

Swetha Dhinesh

15 Jan, 2024

Alternative investment funds are a collection of pooled investment funds and conventional methods to diversify portfolios beyond typical traditional methods like cash, stocks, and bonds. It provides the investor with a better rate of return than traditional methods, which invest in AIFs that require more investment and are riskier than traditional ways of investment. They are part of most high-net-worth individuals and family offices. Alternative investment funds aim at a sophisticated investor who is looking to diversify their investments, and they are not aimed at the general public. In this blog, you will learn the concept of alternative investment funds and everything you need to know about alternative investment funds.  

AIFs have greater minimum investments and fees than traditional investments. AIF is difficult to appraise since the asset classes in which it invests are uncommon. Alternative investment fund are illiquid since they are only available to a small number of investors. AIFs have lower transaction costs than traditional investments due to their lower turnover. Alternative funds do not disclose any fund-related information to the public. Alternative investment funds also have fewer opportunities to reach out to potential investors.

Development of AIF in India

As alternative investment funds are more user-friendly, they have become a popular investment option for high-net-worth individuals over the years. It has become more user-friendly as a result of regulatory advancements and shifting norms. 

AIFs provide specialised options, collect funds from sophisticated investors and perhaps greater investment yields. However, the one crore minimum investment requirement is a barrier to access, attracting primarily sophisticated investors seeking a customised investment strategy. According to the Indian Association of Alternative Investment Funds (IAAIF), the AIF category in India has grown tenfold in the last seven years, with assets under administration totalling $7 trillion. These investments frequently have a 10-year time horizon, needing ongoing contact with investors by financial advisors to manage expectations. 

In comparison to a decade earlier, when foreign investors accounted for the majority of capital, over 80-90% of funds obtained now are from domestic investors. Current trends imply that AIFs could become a massive sector in the future, rivalling India’s $46 trillion mutual fund industry.

Key Characteristics to Invest in AIFs

A vast array of assets and methods are sought after by alternative investors. But generally speaking, they are distinguished by:-

1. Minimal association with conventional investments such as stocks and bonds.
2. Greater potential for return than with typical investments.
3. More obscure and frequently non-liquid assets. 
4. Longer lock-in period, which means that interests or shares could not be able to be sold or redeemed every day.
5. Exposure to less liquid assets is aided by this.
6. Frequently intricate risk-return profiles and investment arrangements.
7. Higher minimum investment requirements are typical 
8. The unique risk profile should be understood prior to investment.

What are the various types of AIFs in India?

The following are the various types of Alternative Investment Funds in India:-

Category – I

Alternate Investment Funds invest in startups, SME funds, and new economically viable enterprises with strong growth potential, which is an investment goal of many investors. Among them are the following:-

Infrastructure fund – These investment schemes generally invest in enterprises that build infrastructure, such as railroads, airports, and ports. Individuals who want to invest in infrastructure development typically use these funds.

Venture capital funds (VCF) – Venture capital funds (VCF) invest in potential entrepreneurial enterprises that require a significant amount of funding. VCF is typically invested in by high-net-worth individuals with a high-risk, high-return policy.   

Angel funding – This form typically invests in fresh startups that are not funded by venture capital funds. Each angel fund investor typically contributes a minimum of Rs.25 lakh.

Social venture capital – Social venture fund plans invest in enterprises that engage in philanthropic activities. They help people raise their living conditions while also providing significant returns to their investors. 

Category II

Alternative investment funds do not incur debt for reasons other than day-to-day operations and include the following category of AIF:-

Debt funds – These funds invest in debt instruments issued by unlisted companies that adhere to excellent corporate governance practices and have reasonable growth potential. They are not, however, suitable for conservative investors due to their low credit rating. 

Funds of Funds – Funds of funds are investment strategies that invest in other Alternative Investment Funds. 

Private equity funds – Private equity funds engage in unlisted private companies that are having trouble raising financing through the issuance of equity and debt instruments.  

Category III

Category 3 funds, which may be leveraged and employ sophisticated trading tactics, include the following:-

Hedged funds – Hedge funds¹ raise capital from investors and corporations to invest in domestic and international debt and stock markets. These schemes employ an aggressive investment strategy to give investors a larger return on investment. They also have a high expense ratio.

Private investment in public equity fund (PIPE) – This sort of funding strategy invests in public companies by purchasing their stock at a discount. 

What are the Benefits of Alternate Investment Funds in India?

Investing in a defined investment policy of alternative investment funds will give you the following benefits:-

Protection against volatility

In accordance with a defined investment, investing in Alternative Investment Funds is a terrific strategy to safeguard and stabilise your portfolio from volatility. These schemes do not invest their funds in publicly traded investment choices. As a result, they are unrelated to the broader markets and do not vary in response to their ups and downs.

Outstanding portfolio diversification

Investing in an AIF allocates its funds to a far broader range of assets than most other investment vehicles. As a result, they offer good portfolio diversity and can protect your investments during market volatility or financial catastrophe. 

Allows for specialist investments

Alternative investment funds enable you to invest in specialised investment possibilities not available to other investors. These startups include those involved in a burgeoning trend or those developing innovative technology.

Provides more stability

Alternative investment funds are not connected to the stock market. As a result, they have lower volatility than equities investments. As a result, alternative investment funds are a safe bet for investors with a low-risk tolerance.

Profitable outcomes

AIF investment returns are advantageous since these funds offer a wide range of investment possibilities. When compared to traditional investment vehicles, they provide a better source of passive income. Furthermore, because these schemes are not linked to the stock market, the returns are less volatile. 

Regulatory Oversight

The Securities and Exchange Board of India (SEBI) is an investor protection regulating authority for Alternative Investment Funds. This regulatory system ensures compliance, openness, and fairness while also increasing investor confidence. 

Factors to consider before investing in an Alternative Investment Funds

Below are some of the important factors to consider before investing in alternative investment funds:-

Risk Tolerance

Alternative investment funds are riskier than typical investments. Before investing, investors should evaluate their risk tolerance. 

Due Process

Before investing, prioritise thorough research. Examine the track record of the fund manager (or alternative investing platforms), investment strategy, and performance history.

Periods of Liquidity and Lock-In

Alternative investment funds frequently have lengthy lock-in periods (at least three years) and extremely low liquidity. Before investing in these funds, consider your investment horizon and liquidity requirements.

Regulatory Structure

Learn about the regulatory landscape around alternative investments. Check for compliance and learn about the investment protection mechanisms in place.

Taxes on investments in Alternative Investment Funds

Here are some issues to consider about alternative investment funds’ investment taxation before choosing one of these schemes:-

Alternative investment funds in categories 1 and 2 are not taxed in the hands of the AIF. However, if you gain money by investing in them, taxes will be levied according to your current tax bracket.

If you invest in an alternative investment fund that allocates its funds to equity investments, you must pay a capital gain tax of 10% on long-term gains and 15% on short-term gains. 

Category 3 funds are taxed at the highest possible rate of 42.7%. If you invest in them, you will receive your profits after this deduction.  

Conclusion 

Many savings institutions are shifting to new conventional investment strategies. There is a wonderful opportunity to experiment with portfolio investing and traditional alternative investments such as Alternate Investment Funds (AIF). Alternative investments may present an intriguing possibility to generate passive income in 2024. To summarise, as a sensible investor, one might consider alternative investments as a form of portfolio diversity rather than a long-term strategy. 

FAQs

1. https://en.wikipedia.org/wiki/Hedge_fund