Definition of Alternative Investment Funds By SEBI
An AIF is defined as a fund formed or registered in India, under regulation 2(1)(b) of SEBI Regulations 2012, as a Limited Liability Partnership (LLP), corporation, trust, or body corporate that:
It is a privately pooled investment entity that collects assets from investors, both domestic and international, and invests them according to a stated investment policy to benefit its stakeholders.
It excludes funds subject to the SEBI (Collective Investment Schemes) Laws, 1999, SEBI (Mutual Funds) Regulations, 1996, or any other SEBI regulations governing fund management.
Category 1
This category includes funds that invest in small and medium-sized enterprises (SMEs), start-ups, and new businesses with strong growth potential that are considered socially and economically viable.
Since these initiatives have a multiplier effect on the economy in terms of growth and job creation, the government supports and encourages investment in them. This category includes.
1. Infrastructure Funds
This fund invests in public assets such as road and rail infrastructure, airports, and communication infrastructure, among others.
Since the infrastructure industry has high barriers to entry and relatively limited competition, investors who are positive about its future expansion can invest in the fund.
The government can provide tax incentives to Infrastructure Funds that invest in socially desirable or viable projects.
2. Angel funds
This is a type of venture capital fund where fund managers pool money from several “angel” investors to invest in early-stage companies.
When new ventures become profitable, investors receive dividends. An “angel investor” is a person who wants to participate in an angel fund and contribute expertise in the field of business management, thereby supporting the growth of the company.
3. Venture Capital Funds
Venture capital funds invest in high-growth startups that are cash-strapped and need financing to develop or expand their operations.
Since it is difficult for entrepreneurs and new businesses to get cash through traditional banking, venture capital funds have become the most preferred source of capital.
4. Social Venture Funds
Social Venture Fund (SVF), which invests in companies with a strong social conscience and a desire to have a good impact on society, is one example of socially responsible investing.
The aim of these companies is to make money while solving environmental and social problems. Despite being a philanthropic investment, a profit can be expected as the businesses will continue to generate revenue.
Additional read: Investment options for self-employed parents
Category 2
Funds that are invested in both shares and debt instruments are included in this category. Additionally, those funds that are not currently classified as Category 1 or 3 are also included in this category.
The government does not offer any tax benefits for investments in AIFs Category 2. This category includes:
1. Fund of Funds
This fund is a combination of many AIFs. Rather than building its own portfolio or determining which particular sector to invest in, the fund’s investment strategy is to invest in a portfolio of other AIFs.
However, unlike a fund of funds within mutual funds, a fund of funds within an AIF cannot issue publicly traded fund units.
2. Debt Funds
This fund essentially invests in debt instruments issued by both publicly traded and private companies. Companies with poor credit ratings are more likely to issue high-yield debt securities that are associated with high risk.
As a result, companies with high expansion potential and strong corporate standards, but capital constraints, can be a good investment alternative for debt fund investors.
As the Alternative Investment Fund is a privately incorporated investment entity, the money deposited in it cannot be used for lending as per SEBI regulations.
3. Private Equity Funds
Invest in private companies that are not publicly listed and have a limited number of shareholders because unincorporated and illegal private businesses cannot raise funds from PE funds.
In addition, these companies provide their clients with a broad portfolio of stocks, thereby minimizing investment risk. A PE fund usually has a predetermined investment horizon of 4-7 years.
After seven years, the company aims to be able to exit the investment with a reasonable return.
Category 3
AIFs in Category 3 are those that provide returns over a short period of time. These funds use several complicated and diversified trading methods to achieve their goals.
The government provides no relief or incentive for these funds. This category includes:
1. Hedge funds
To achieve high returns, a hedge fund combines funds from institutional and accredited investors and invests in domestic and foreign markets.
They have a high level of leverage and are aggressive with their investment portfolio. Unlike their competitors, such as mutual funds and other investment vehicles, hedge funds are less regulated.
These funds typically charge a 2% asset management fee and keep 20% of the profit earned as a fee.
2. Private Investments in Public Equity Funds
The purchase of shares of publicly traded stock at a reduced price is referred to as a private investment in public equity funds.
This allows the investor to get a stake in the business while the company selling the stake benefits from the cash flow.
Pros and Cons AIFs
Like all financial instruments, have their pros and cons. Below is a list of pros and cons:
Pros
- Diversification of market strategies and investment types is facilitated with the help of AIF.
- It comes with a strong potential to improve investment performance.
- Because their success is not based on the ups and downs of the stock market, alternative investments can help reduce the volatility often associated with traditional investments.
Cons
- Alternative investment funds are complex and doing your research before investing in them is essential.
- A large initial investment is required, which is beyond the reach of retail investors.
Conclusion
AIFs are an attractive investment option for HNI investors who aspire to receive high risks and returns. Investors should conduct proper market research about AIF investment options before investing.
