What Is Category 2 AIF Investment?

Introduction

Investing in AIFs (Alternative Investment Funds) has always been a favorite subject of investors, especially HNIs. In July 2025, HNIs, Ultra HNIs, and family offices pumped around ₹74,000 crore in real estate via AIF Category 2. But what are AIFs?

In simple terms, AlFs are investment options like mutual funds, but they don't invest in stocks, bonds, or ETFs. Instead, it focuses on non-traditional assets like private equity, venture capital, real estate, debt funds, and others.

Based on these investment options, there are three further categories. Categories I, II, and III. While the AIF Cat 1 focuses on venture capital, SMEs, and angel funds, AIF II caters to private equity, debt funds, real estate, and similar other funds. Likewise, the Cat III follows complex trading strategies inclusive of leverage.

In this blog, we will focus on AIF Category 2, including its types, who can invest in them, and the applicable Category 2 AIF taxation.

What Is Category II AIF?

Category 2 AIF are alternative investments that invest in both private equity and debt categories. It pools money from investors and invests the same in debt or equity securities of listed or unlisted companies. These funds do not undertake leverage or borrow other than to meet day-to-day operational requirements. ​

Think of Category II AIFs as privately pooled funds that channel money into growth-oriented unlisted businesses, real estate, private equity, and structured debt deals.

But what's the purpose of having Category II AIF?

Well, there are certain incentives uncovered in Category 1 and Category 3 AIFs. Thus, to bring a common ground, the Securities and Exchange Board of India (SEBI) pushed a new category (like AIF II) to incentivize private equity and debt securities.

Key Features Of Category II AIFs

Unlike Cat 1 AIF, the second category does not focus on government incentives. Instead, it has major attention over non-traditional assets, which cumulate its characteristics.

Some of the key features of Category II AIFs include;

Key Features Of Category II AIFs

Unlike Cat 1 AIF, the second category does not focus on government incentives. Instead, it has major attention over non-traditional assets, which cumulate its characteristics.

Some of the key features of Category II AIFs include:

• Wide Investment Scope: This category can invest in equity, debt, or hybrid instruments across private markets.
• No Special Incentives: AIF Category II does not receive government or SEBI-backed benefits like Category I.
• No Speculative Strategies: SEBI prohibits fund managers from employing hedge fund-style or complex trading strategies.
• Limited Borrowing: They can borrow only for short-term needs, within strict limits.
• Medium to Long-Term Horizon: Only those investors willing to stay invested for 5–7 years or more can find this AIF comfortable.
• High Minimum Investment: A minimum of ₹1 crore is mandatory, making it exclusive to HNIs.
• Pass-Through Taxation: Most income is taxed directly in the hands of investors, not the fund.

Types Of Funds In Category 2 AIF

Typically, there are four major types of funds available in the Category 2 AIF. It includes;

Private Equity Funds

As the name suggests, private equity funds invest in private companies through the purchase of unlisted shares. Later, they earn their share and exit via IPO, buybacks, or sale made to other investors.

Here, the minimum investment limit is ₹1 crore, while for any employee or director of that AIF, the limit is ₹25 lakhs.

Real Estate Funds

With the recent reports, India's real estate sector shows a promising CAGR growth of 15.5% between 2023 and 2028. As a result, the real estate fund leverages this sector. It invests HNIs' money in commercial, residential, or mixed-use development projects.

They invest majorly in;

• Rent-yielding commercial assets (particularly office spaces)
• Infrastructure projects include highways, transmission lines, and renewables
• Warehousing infrastructure
• Greenfield warehousing projects
• Data centres
• Residential developments

AIFs provide access to high-quality assets with blue-chip tenants. At the back end, the fund manager manages the entire lifecycle, from land acquisition to leasing.

In real estate funds, the ticket size ranges from ₹1 crore, and extends up to ₹100 crores for family offices.

Debt Funds

Those debt securities of unlisted companies fall under Category 2 AIF - Debt funds. They invest in the following securities:

• Corporate bonds
• Non-convertible debentures (NCDs)
• Commercial papers
• Government securities
• Distressed Debt (in some cases)

However, the fund house cannot use the investor's money to lend money or give loans. They can only invest in issued securities with full transparency and compliance.

Funds of Funds (FoF)

When a fund decides to invest in the units of other AIFs, it is known as a Fund of Funds (FoF). Here, the pooled money is invested in a collection of mutual funds, ETFs, or any other funds.

Who Can Invest in AIF Category 2?

Category II AIFs are designed for sophisticated, accredited investors (minimum net worth of ₹2 crore and annual income of ₹50 lakhs) who have the risk appetite and patience for long-term, alternative investments.

• High-Net-Worth Individuals (HNIs): With a minimum ticket size of ₹1 crore, these funds are primarily meant for wealthy investors and Ultra HNIs.
• Institutional Investors: Banks, pension funds, insurance companies, and corporates often participate in AIF II to diversify portfolios.
• Family Offices & Ultra-HNIs: Ideal for those seeking access to private equity, debt, and real estate opportunities outside public markets.
• NRIs and Foreign Investors: Eligible to invest, subject to SEBI and RBI regulations.

Bonus Fact: As of June 2025, more than ₹3.8 lakh crores was made in Category II AIF in India.

Major SEBI Rules for Category 2 AIFs

• Do not get any government/SEBI incentives (unlike Cat I).
• No leverage/borrowing except for short-term needs.
• Include sub-categories like Private Equity Funds, Debt Funds, Structured Credit Funds, and Fund of Funds.
• Entry ticket of ₹1 crore makes it exclusive to HNIs and institutional investors.
• A minimum tenure of 3 years or more, with approval of 2/3rd unit holders.
• Closed-ended fund with a varying tenure of 5–8 years, depending on the scheme.

Taxation Of Category 2 AIFs

The Category 2 AIF taxation differs for each fund. Below is a summary:

Sr No.	Fund Type	Holding Period	Nature of Income	Tax Treatment
1	Private Equity Funds	5–10 years	Capital Gains	STCG: 15% LTCG: 20% (above ₹1 lakh)
2	Real Estate Funds	< 36 months / > 36 months	Capital Gains	STCG: Slab Rate LTCG: 20% with indexation
3	Debt Funds	Varies	Interest + Capital Gains	Taxed as per investor’s slab / capital gain rules
4	Structured Credit Deals	Varies	Interest + Capital Gains	Taxed as per investor’s slab / capital gain rules
5	Funds of Funds (FoF)	As per underlying fund type	Varies	Follows underlying AIF taxation rules
6	Any Fund (Business Income)	Not Applicable	Business Income	Taxed at fund level before distribution

Final Thoughts

AIF Category 2 funds are a sweet spot for those preferring unlisted securities, unlike Cat I and Cat III AIF. This type offers investors a thrilling opportunity to invest beyond traditional assets like stocks and bonds.

That said, these AIF funds aren't for everyone. With a minimum corpus of ₹1 crore and long lock-in periods, it requires a long-term horizon and patience. Also, the Category 2 AIF taxation differs with the holding period and fund type.

If you're looking to balance growth potential with portfolio diversification, Category II AIFs could be worth exploring. But as we say, always take guidance from a trusted financial advisor who can help align them with your overall wealth strategy.

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