Types of Alternative Investment Funds
- What Are AIFs (Alternative Investment Funds)?
- Understanding Different Types of Alternative Investment Funds
- Who Can Invest In AIFs?
- Things To Consider When Investing In AIFs
- Taxation Of AIFs
- Conclusion
Introduction
In the new age of investing, multiple new avenues of investments such as private equity, venture capital, and hedge funds have emerged. It has brought a new investment opportunity for HNIs (High net-worth Individuals) and Ultra-HNIs to diversify. What if you could invest not just single-handedly, but through a fund?
That's what Alternative Investment Funds (AIFs) aim to achieve!
In this blog, let us explore the different types of alternative investment funds, who can invest in them, what's kept for you as an HNI, and much more.
Stay tuned to diversify the language of investments with AIFs!
What Are AIFs (Alternative Investment Funds)?
AIFs (also Alternative Investment Funds) are investment vehicles where amount is pooled from specific investors and later invested in non-traditional assets. With that said, these assets don't define stocks, bonds, currencies, etc. Instead, it utilizes other assets like private equity, venture capital, real estate, and hedge funds. Akin to mutual funds, they are formed as trusts, LLPs (and corporations) to invest further.
When speaking about specific investors, it caters specifically to HNIs and Ultra HNIs who can invest additional capital. In short, they are not open for retail investors and hence, it becomes an exclusive opportunity for HNIs.
Here, the minimum investment required for AIFs is ₹1 crore. For directors, fund managers, and employees, the corpus amount is ₹25 lakhs.
Understanding Different Types of Alternative Investment Funds
Based on the SEBI rules, there are primarily three categories or types of AIFs available.
Category I
This type of AIF invests in Startups, Early-Stage Ventures, Venture capital, Social Ventures, SMEs (Small and Medium Enterprises), Infrastructure, or other sectors that the government or regulators consider economically and socially desirable.
- Angel Fund: A type of AIF where individual investors (angels) pool money to invest in early-stage startups, typically offering mentorship along with funding. However, the minimum investment corpus here is ₹25 lakh per investor.
- Venture Capital Funds: AIFs invest in high-growth startups and emerging businesses with strong potential, usually in exchange for equity. They technically support the entrepreneurs in the early stages to scale, innovate, and grow.
- SME Fund: This fund focuses on investing in Small and Medium Enterprises (SMEs), which are already established or in the early stages.
- Social venture funds: It mainly consists of enterprises that address social and environmental issues. Despite its philanthropic vision, this AIF tries to generate sufficient returns for the investors.
- Infrastructure funds: They invest in large-scale public or private infrastructure projects like roads, power, or urban development, often with returns meant to achieve long-term objectives.
Category II
It primarily focuses on Private Equity, Real Estate, and Debt Funds as the primary sources of investment. Here, Category II AIFs invest in debt or equity securities of listed or unlisted companies. Moreover, these funds do not engage in leverage or borrowing, except to meet daily requirements.
- Private Equity Funds: These funds invest in privately held companies (or acquire public companies) to initiate capital appreciation through restructuring or growth.
- Debt Funds: These funds primarily invest in debt instruments, such as bonds, debentures, or loans, generating regular income through interest payments.
- Real Estate Funds: Pool money to invest in commercial or residential property projects, earning returns from rental income, leasing, or property value appreciation.
Category III
Focusing on complex strategies, Category III AIFs invest in Hedge Funds, Listed And Unlisted Companies, Derivatives, Structured Products, and Commodity Derivatives, among other assets.
- Hedge Funds: As the name suggests, a hedge fund tries to balance the fund with complex strategies to maintain an effective return rate.
- PIPE Funds: Private Investment in Public Equity (or PIPE) is a fund arrangement where private investors can buy shares of public companies at a discounted price. It is often through private placements that firms raise quick capital.
- Structured Credit Funds: These are investment vehicles that pool various types of debt instruments (often backed by assets) and repackage them into securities for investors.
- Long-short or Long-only trading strategies: This includes derivatives trading aimed at optimizing investments in commodities and equity products.
Who Can Invest In AIFs?
Here's who can participate and invest in different types of alternative investment funds.
- Resident Indians
- Non-Resident Indians (NRIs)
- Foreign Individuals
- High net-worth individuals (HNIs)
- Institutional investors and Qualified Institutional Buyer (QIB)
- Joint investors (not more than 2 persons)
- i. An investor and his/her spouse
- ii. An investor and his/her parent
- iii. An investor and his/her daughter/son.
Taxation Of AIFs: All You Need To Know
Below are the taxes levied on alternative investment funds. The following table simplifies your doubts:
| Category I & II AIFs | Category III AIF | Category III AIFs in GIFT City (Special Regime) | |
|---|---|---|---|
| Capital gains & interest | Taxed at investor level and exempt at fund level. | Gains are exempt for both LLP and investors. | - |
| Business income | Taxed at fund level (30% for residents, up to 39% for non-residents). It is later exempt for investors when filing tax returns. | Income is taxed either in the hands of the trustee or investors. Business income is taxed at the maximum marginal rate at the trust level. | - |
| NRIs | Taxed directly and must file annual ITR. | ——— |
For NRIs:
|
| Distribution tax | 12.5% for Indian retail investors and standard rates for foreign investors. | Companies are taxed at corporate rates. Also, dividends paid to investors attract TDS. |
Things To Consider When Investing In AIFs
When investing in different types of AIFs, do consider these points upfront.
- Category I AIFs and Category II AIFs cannot invest more than 25% of the funds in a company.
- Likewise, for Category III AIF, the limit is 10%.
- Any uninvested amount must be diverted towards liquid assets (until fund deploys as per its objective).
- Category I AIF and Category II AIFs "primarily invest" in unlisted securities.
- Each scheme of AIFs (except angel fund) must have a minimum investment corpus of ₹25 crore. For angel fund, the amount is ₹10 crore.
Conclusion
On a topical level, AIFs are not investment trusts but a hub of non-traditional assets. From different types of alternative investment funds (AIFs) like Category I, II, and III, there are multiple assets covered. Examples include private equity, hedge funds, venture capital, debt funds, SME funds, and many more. With such a wide variety, it syncs well with the requirements of HNIs and UHNIs. But, most importantly, it is necessary to look at the corpus limits and applicable taxation of AIFs in India.
If you feel your portfolio should get a makeover with AIFs, consider consulting an AIF provider for more information.
Disclaimer: The above/said mentioned information is for educational/knowledge purposes and has no influence on investment/trading decisions.
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