A Deep Dive into Alternative Investment Funds and Their Superior Returns

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Recently, there has been a surge in interest surrounding the Alternate Investment Fund, an investment vehicle worth exploring. Today, we will delve into the definition of an alternative investment fund, its unique features, and the individuals it caters to. Much like mutual funds, alternative investment funds form a separate class of investments and are regulated by SEBI's Alternate Investment Fund Regulation 2012.

With regulations in place, this asset class offers the possibility of a reasonably regulated return. The performance of the Alternate Investment Fund supports this, as it has grown to a value of over eight lakh crores as of March 31, 2023. This significant growth indicates that it is no longer a small asset class.

A significant number of investments are being made by wealthy individuals and institutions, making this investment venue quite appealing. SEBI has classified alternate investment funds (AIF) into three categories.

Categories of Alternate Investment Funds

Category 1 Alternate Investment Funds - Finsherpa

Category 1 

Venture Capital Funds

The initial type of funds in category one is venture capital funds. These funds pool money from investors and invest it in up-and-coming private ventures. These funds are considered high-risk due to the unproven nature of the business models. Consequently, the potential return is also high. The fund manager plays a crucial role in assessing the risk and offering investors an excellent investment opportunity.

Venture capital funds are the top priority under category one because, typically, out of ten investments made, around six or seven fail, but the remaining three or four generate substantial profits and returns.

Angel Funds

An Angel Fund is the second type of fund. It serves as the initial source of funding for new startups and entrepreneurs. When seeking capital, these individuals approach angel investment firms to determine if their idea has commercial potential. Although angel funds carry higher risks compared to venture capital funds, the potential returns can be remarkable.

Infrastructure Funds

Infrastructure funds are a type of investment that combines money from multiple investors to support infrastructure projects. These funds invest in both equity and debt, allowing investors to benefit from them over extended periods. se investments are usually favored by large institutional players who can hold them for extended periods. Infrastructure funds typically have a duration of 10 to 15 years.

Social Venture

The social venture is the last fund in category one. These ventures are driven by a genuine concern for society and strive to bring about positive change for a specific group of people. The returns may not be the best, but people still invest because they believe it supports a specific cause.

This is the fourth type of fund that category one offers. However, apart from angel investing, all other investments require a minimum investment of one crore. It is not for regular investors, but only for high net-worth individuals. In the case of angel investing, if the person is a director, employee, or associate of that angel fund, their investment can be 25 lakhs. For everyone else, the minimum investment is one crore.

Category 1 Alternate Investment Funds - Minimum Investment - Finsherpa

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Category 2 

Private Equity Funds

Category 2 offers two classifications of funds. The first classification is private equity funds. These funds raise capital from investors to invest in companies that have not yet been listed on the secondary or primary market.

These companies have great potential and a proven track record, but they are not yet available for public investment. Before going public, some of these companies require funding to expand their business and achieve a successful listing. This is where private equity funds come in, investing at this stage. However, it's important to note that these investments carry a slightly higher risk compared to publicly listed stocks.

However, if they strike it big, these funds can offer a significantly higher return compared to publicly traded stocks. Yet, there is a risk involved as some companies may never go public or face delays in doing so. Therefore, investors must exercise patience. Private equity funds usually have a tenure of 5 to 8 years, requiring investors to possess the necessary patience and time to enjoy the rewards.

Category 2 - Alternate Investment Funds - Finsherpa

Debt Funds

Similarly, there is another division within this second category known as debt funds. Debt funds gather money from investors, but instead of investing in company ownership, they invest in debt securities of unlisted companies. Is this considered a risky venture? Yes, indeed. It carries a higher risk, especially when dealing with unfamiliar and unlisted companies. However, the fund manager's responsibility is to evaluate and analyze the level of risk involved.

As a result, he is capable of playing. The typical destinations for these investments are bonds and debentures issued by unlisted companies. These companies are often subsidiaries of reputable firms or emerging businesses with solid financial backing. However, these companies may not have access to bank support at that particular moment due to their lack of established history.

These funds bring immense happiness as they are formed within the circle or group of blue chips. Being a subsidiary or having a letter of guarantee from a blue chip company, there is a strong belief that these companies will be financially stable and provide good returns. Since they are not publicly listed, they can also offer high returns to investors. Hence, they meet all the requirements. As a result, there is also a popular debt fund in the category two investment scheme.

Check out the video link for a more in-depth understanding 

Category 3 

Category 3 - Alternate Investment Funds - Finsherpa

Private Investment in Public Equity - PIPE

There are two types of funds under category three. The first type of fund is PIPE, which stands for private investment in public equity. It is an innovative concept where fund managers combine investors' funds to invest in a company's secondary offering. Instead of a listed company issuing a rights issue, they can opt for a private placement with certain funds. These funds will later sell their holdings in the market through a secondary sale.

The purpose is to provide the company with a large sum of money all at once, which can be used to expand their business. This alternative route saves the company from the complexities and formalities of going through the Sebi process for a rights issue, making it a simpler way to gather a lump sum. Many existing listed corporations find PIPE to be an intriguing method for raising funds, which falls under category three.

Hedge Funds

The third category is where hedge fund managers belong. But why do they choose this category? It's because they invest in various asset classes, such as listed equity, overseas markets, debt, and every other type of asset.

These fund managers are extremely opportunistic and their main goal is to generate the highest possible return. These funds are specifically designed for wealthy individuals and accredited investors who are well aware of the risks involved. Category three investments only include these two types of investments. As I mentioned before, AIF is a product that offers high rewards but also comes with high risks.

The minimum investment threshold for AIF, as mandated by Sebi, is one crore rupees. Typically, investors need to thoroughly examine the offer document and understand all the details before proceeding with the investment. Once the investor agrees to participate, they sign a commitment sheet, which formalizes the agreement with the fund. The fund can be structured as a company, limited liability partnership, or trust, and the relevant documentation is signed accordingly.

The investor has committed to investing a value of more than one crore and can choose to invest either in a lump sum or in tranches of 25 lakhs to 20 lakhs, depending on their deployment requirements for 12 to 18 months. This is the structure of the fund.

Check out the video link for a more in-depth understanding 


In terms of taxation, Category One and Category Two are classified as pass-through vehicles. This means that the fund manager executes the trades within the fund, but the investor is responsible for the tax liability. As an individual investor, you will need to report these transactions and pay the applicable taxes.

Category Three is a part of the fund and is subject to its taxation laws. This means that any transactions conducted within Category Three, whether involving hedge funds or other funds, are subject to taxation. However, any profits generated from the fund are exempt from taxes and are not taxed for the investor.

What are the advantages of investing in alternate investment funds?

High Return Potential

AIF investments offer the possibility of achieving exceptionally high returns because they invest in various asset classes. This superior return potential is what attracts people to these investments. Nevertheless, it is crucial to acknowledge that these investments also come with increased risks, making them unsuitable for common investors.

Distinct Diversification Opportunity

They offer a special opportunity for diversification. AIFs engage in investments that are unlike listed entities or mutual funds. They belong to a completely different asset class. This provides investors with a fantastic chance to diversify their investment options.

Less Volatile

In most cases, investments in these AIFs are not very volatile. Since they are not listed companies, there are no benchmarks. As a result, investors do not experience or feel the regular volatility in their portfolios. This makes them seem less volatile. However, it's important to note that unless the investment is disinvested, the actual valuations remain unknown and can change frequently. These are the advantages of investing in AIFs.

Check out the video link for a more in-depth understanding 

What are the disadvantages of investing in alternate investment funds?

AIF Investments are Long-term Investments

A major drawback of AIF Investments is their long-term nature. Usually, there is a legal requirement to hold them for at least 3 to 4 years. The majority of AIFs have a duration of 7 to 10 years. If you change your mind and want to exit, it can be quite challenging. There are limited chances for immediate liquidity, and you have to wait for your turn.

Selling it earlier will result in a significant loss for you. This product is not easily sold, and it lacks transparency and predictability in terms of returns. Generally, it is advisable to have funds that can be invested for a minimum of ten years before considering AIF investments.

The Bottom Line

AIF is an excellent way for investors to diversify their portfolios, particularly for high net-worth individuals with a portfolio size ranging from five to 25 crores. It offers a promising investment option. However, it's important to understand the risks involved and thoroughly research before making any commitments.

Investing in these funds is not suitable for ordinary people. So, if you don't like taking risks, it's better to avoid them. AIFs are still in the early stages in our country. We think it will take a while before they develop and become available to a wider range of people.

However, it is worth mentioning that this is also a fascinating period with attractive and favorable returns. Therefore, if you are willing to take risks and if this alternative investment constitutes 10% or less of your total portfolio, it might be a good idea to consider it.

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