Alternative Investment Funds (“AIF“) are now a well-known phenomenon for investors looking for diversified portfolios and willing to experiment with a method other than the traditional investment method, i.e., stocks, bonds, mutual funds, etc. Most of the AIFs are held by high-net-worth individuals and institutional investors because of their complex nature, high risk, lack of liquidity and limited compliances. Venture Capital Funds, Angel Investment Funds, Hedge Funds, Real Estate Funds, Private Equity are common alternative investments.
UNDERSTANDING AIF
AIFs are privately pooled investment vehicles established in India under the Securities and Exchange Board of India (“SEBI“) Regulations. These regulations are formed to regularize the collection of funds from the investors and invest them in the spirit of defined investment policies for the benefit of investors.
Alternative Investment Funds do not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, the SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities.
AIF’s are incorporated in the form of Trust or a Limited Liability Partnership (LLP) or a Company or a Body corporate. However, as per available data, 97% of the AIFs prefer to be incorporated as Trust. SEBI has categorized the AIF under which application can be sought by the applicant into three categories and further classified into sub-categories:
| CATEGORY I | CATEGORY II | CATEGORY III |
| Ø Venture Capital Fund
Ø Angel Funds Ø SME Funds Ø Social Venture Funds Ø Infrastructure Funds |
Funds not following in Category I and Category III are permitted under this Category. Some of the Funds are:
Ø Private Equity Funds Ø Real Estate Funds Ø Funds for Distressed Assets |
Ø Hedge Funds
Ø Private Investment in Public Equity Funds |
Having mentioned the categories above, explaining them for easy reference:
Category I
- Venture Capital Funds: Venture Capital Funds are investment funds that invest in start-ups and small businesses mainly involving new services, technologies and new products
- Small and Medium Enterprises (SME) Funds: These funds invest in micro, small and medium enterprises or in securities of small and medium enterprises proposed to be listed in SME exchange. They require a minimum investment of INR 1 crore and a lock-in period of 3 years and can also opt for an extension of 2 years.
- Social Venture Funds: Social Venture funds are the funds where the investment is made in businesses that aim at influencing the social lives of the people positively and delivering social benefits. The businesses targeted under such investments are education and agriculture, healthcare, clean energy, etc.
- Infrastructure Fund: Infrastructure is a very common word and used in day-to-day life which is related to roads, railways, renewable energy, water supplies, etc. These are Category I AIF that invest in businesses that develop infrastructure projects ultimately developing the country’s economy.
Category II
- Private Equity Funds: Private Equity Funds also known as PE Funds are the funds that invest in unlisted private companies and acquire ownership by taking up their shares.
- Funds of distressed assets: Category II investment which invests in the assets of the company which have turned to be non-performing ones with the intention that all assets are not bad assets and can provide good results and returns.
Category III
- Hedge Funds: Hedge Funds are Category III AIFs that employ strategies that are diverse and complex and trade in securities and products which have diverse risks, including listed and unlisted derivatives.
- PIPE Funds: PIPE Funds which means Private Investment in Public Equity. It is the investment of private funds in public equities or public companies. It means buying publicly traded stocks at discounted prices.
EXEMPTIONS:
As per Rule 2(1)(b) of SEBI (Alternative Investment Funds) Regulations, 2012, the following shall not be considered as Alternative Investment Funds:
- Family trusts set up for the benefit of relatives (“relatives” as defined under Companies Act, 2013);
- ESOP Trusts set up under the Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014 or as permitted under Companies Act, 2013;
- Employee welfare trusts or gratuity trusts set up for the benefit of employees;
- Holding companies as defined under sub-section 46 of section 2 of Companies Act, 2013
- Other special purpose vehicles not established by fund managers, including securitization trusts, regulated under a specific regulatory framework;
- Funds managed by a securitization company or reconstruction company which is registered with the Reserve Bank of India under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; and any such pool of funds which any other regulator in India directly regulates.
WHY AIF?
Conclusion- In India, during the last few years, AIFs have been used by large institutions and becoming more mainstream day by day. One of the unquestionable characteristics of the AIFs is that they can improve the overall risk and return of investment by having a non-traditional approach and the ability to invest in areas where traditional investments cannot. A modest allocation to the best alternatives is prudent. However, unique risks are an integral part of the AIFs because of the non-traditional approach and structure of AIFs investments. Investors should always be aware of such risks. Investors should always consider each fund’s objectives, risks, charges, and expenses and invest carefully.
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