Benefits of Investing in AIF (Alternative Investment Funds)

Ankita Tiwari

01 Jun, 2023

Alternative Investment Fund (AIF) is a privately pooled investment fund that collects funds from the sophisticated individual as well as institutional investors and invests it as per the prescribed policy. AIF pools the fund of domestic as well as foreign investors. AIF can be established in the form of a Company, Trust, Body Corporate, or Limited Liability Partnership (LLP). It is an unconventional instrument and differs from other investment instruments. It does not fall under the purview of any regulatory agency, even though it has been recognized by the Securities and Exchange Board of India (SEBI). SEBI has also formulated a separate set of rules for AIFs i.e. the SEBI (Alternative Investment Fund) Regulation, 2012. Here we discuss Benefits of Investing in AIF (Alternative Investment Funds).

AIFs are of three categories i.e. Category I, Category II, and Category III. Each category is further sub-categorized. An AIF must acquire accreditation in any one of the following three categories of AIF:

1. Category I AIF – It invests in start-ups, small-scale enterprises (SMEs), and economically and socially viable industries. These categories include venture capital funds, social venture funds, infrastructure funds, and angel funds.
2. Category II AIF – This category AIF invests in private equity or debt funds for which no explicit subsidies or concessions are provided by the government or any other regulator.
3. Category III AIF – It invests in hedge funds, funds traded to make a short-term profit, or any other open-ended fund for which no benefit or exemption is provided by the government or any regulator.

Investing in AIFs comes with various benefits as it combines the benefits of both conventional as well as unconventional instruments.

Benefits of investing in AIFs

1. Diversification of Portfolio One of the benefits of investing in AIF is that it offers unique asset allocation and diversification of portfolio. The number of asset classes is more than any other investment vehicle. This is because AIFs are not dependent upon the stock market. This gives flexibility to fund managers while building a portfolio.
2. Not co-related to the Stock Market Investors in the stock market either make big wins or major losses. This is due the stock market fluctuations. The performance of the shares depends upon the market stability and market conditions. An investment that is not correlated to the stock market does not fluctuate with the ups and downs of the market. This is one of the major benefits of investing in AIFs.
3. Lack of Volatility In traditional investments, the share prices fluctuate due to a variety of factors and are not tied to an actual asset. AIF is unrelated to the stock market their returns do not fluctuate with the ups and downs in the market as AIFs are not traded publicly. They are undertaken by way of private placement so unit-holders do not have to face share price fluctuation. To have a stable portfolio, AIF is one of the best investment opportunities.
4. High Potential for Returns AIF is a broader form of investment that offers high returns as compared to the traditional form of investment vehicle. It makes AIF investment one of the best sources of passive income as compared to traditional instruments such as debentures and shares. Further, the minimum dependency on the stock market makes the chances of fluctuations less. They have a higher degree of risk but also strong potential for higher returns. Their high return potential is because they invest in a variety of assets that are not available even in mutual funds.
5. Tax Benefits The tax benefits of investing in AIFs are that AIFs are structured in a way that yields more profit and lesser tax. The tax benefits are also directly passed onto the investor. With several alternative investments, one can keep more profit. The investor also gets the opportunity to become a part-owner of the fund, and the tax benefits get directly passed onto the investor. Two of the major tax benefits of investing in AIFs are pass-through of depreciation and long-term capital gains treatment. Non-cash expenditure is deducted from net income by several real estate funds and syndication, thereby lowering the taxable income. Oil and Gas investments have depreciation or depletion tax treatment which is quite advantageous.
6. Strong Income Generating income from public investments like bonds, dividends, etc can be a difficult task. Cash flow is less as public markets are volatile, thereby increasing the risk of small yield. Even in AIFs, not all investments have high cash flows, but they generally yield a monthly return or a quarterly return. Some also yield strong income about 8-10% annually. Further, many funds are structured in a way that the investors get paid first.
7. Properly Regulated AIF has a separate set of regulations I.e. the SEBI (AIF) Regulation^[1], 2012. Only sophisticated investors who meet certain criteria can invest in AIFs. AIFs also have to comply with various regulations and disclosures and meet certain thresholds such as minimum investment, investment restrictions, etc.
8. Fewer restrictions One of the benefits of investing in AIF is that it is not regulated by SEBI and enjoys fewer restrictions as compared to mutual funds or any other form of investment vehicle.
9. Flexibility AIFs are the most flexible form of investment vehicle. They invest in a wide range of assets and have greater flexibility in their investment strategies. AIFs can also adjust their investment in response to market conditions. This helps generate higher returns for investors.

Conclusion

Now that we have seen the benefits of investing in AIF, we know why they are increasingly popular investment vehicles. It offers a high potential for return, diversification of portfolio, and greater flexibility in comparison to traditional forms of investment options. So it is an attractive investment option for sophisticated investors who are willing to diversify their portfolios and earn higher returns. 

Read our Article: Operational Aspect of Amendment to SEBI AIF Regulations