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Alternative Investment Funds-3

Generally, Alternate Investment Funds are a pooled investment mechanism. It takes the form of a company, trust, corporate, or a limited liability partnership. Section 2(1)(b) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulation Act 2012 defines it.

Unlike other funds, IRDA, PFRDA, or RBI does not regulate these funds. Consequently, High Net Worth individuals or institutions invest in AIF as it requires a huge investment amount in comparison to Mutual Funds.

What are alternative investment funds?

AIF is an investment option. It requires massive investment from the investors. Furthermore, it differs from conventional investment options like stocks, debt securities, etc. AIF invests in real estate, hedge funds, private equity in addition to other avenues. It has gained attention in India in recent years.

Features

  • Firstly, the minimum investment amount required is Rs 1 crore in addition to1000 sophisticated investors.
  • Secondly, angel Funds in contrast require 49 investors. It requires an investment of Rs. 25 per investor.
  • Thirdly, AIF members cannot invite people to subscribe to the fund.

Types of Alternative Investment Funds in India

The SEBI notification lists the AIF into 3 categories, namely, category 1, category 2, and category 3.

Moreover, the minimum qualifying corpus is Rs 20 crores in the above schemes. Angel Funds come under Category 1 and have a corpus of Rs 10 crores.

Category 1 

They are invested in Early-stage start-ups, Venture Capital funds, and Small & Medium Enterprises. They are beneficial to the Indian economy and boosts growth. Consequently, such funds receive concessions and incentives from the SEBI or the government of India.

1. Venture Capital: It is a case in point. VC invests in start-ups with the potential to make it big but is lacking in funds in the initial stage. New businesses and entrepreneurs find it tough to raise funds from capital markets. VC Funds help such businesses and entrepreneurs.

2. Angel Funds: It is a sub-type of venture capital funds. The fund manager subsequently pools the money from Angel investors and invests in upcoming start-ups for their growth. It is under compliance with section III-A of the AIF regulations.

3. SME (Small and Medium Enterprise Funds): These funds invest in micro, small and medium enterprises, listed or unlisted. They raise debt through NBFC. 

  • Minimum investment: Rs 1 crore
  • Minimum lock-in the period : 3 years. Extendable up to 2 years.
  • For qualifying as SME AIF: The minimum investment is 75.

4. Social Venture Capital Funds: These funds invest in companies that have a strong social impact and aim to bring a positive change. They are also called impact funds. These funds solve environmental as well as social problems. They bring a lot of experience, expertise, and technology which makes it conducive for all stakeholders.

  • Minimum investment: Rs 1 crore
  • Minimum lock-in period : 3 years. Extendable up to 2 years.
  • 75% to be invested in unlisted or to be listed companies.

SVCF also offers technical and operational assistance to businesses in addition to seed investments. Furthermore, they help in setting up the business, laying the compliance guidelines. The capital and hurdle rates are shared with the investors. The returns are shared as per the mentioned rules in the offer document.

5. Infrastructure Fund: This fund invests in the development of public assets such as road and rail infrastructure, airports, etc. If the investors feel these sectors have a growth potential they can subsequently invest in this fund. Above all, Capital growth and Dividend income can be the form of returns the investor will get. Consequently, when such a fund invests in socially viable projects the government can extend tax benefits.

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Category 2 

All those funds which invest in debt and equity securities fall under Category 2 AIF. All those funds not listed under Category 1 and 3 by SEBI come under this category. No concession or incentives are provided to these funds government.

Investment Restrictions :

  • Minimum Corpus: Rs 20 crores
  • Lock-in period : 3 years
  • Minimum investment: Rs 1 crore for an investor, for members it is Rs 25 lakhs.
  • These funds can undertake to hedge.
  • Moreover, funds in Category 2 should get valuations from independent valuers every 6 months.

Following sub-categories are,

1. Private Equity Fund: These funds in effect invest in unlisted private companies. They assume the ownership of the company upon their investment. Furthermore, as private companies are not able to raise capital from equity or debt, they choose PE funds. The Lock-in period is 4 to 7 years. In addition to being a fund of choice for companies, they offer diversification of portfolio which lowers the risk.

2. Real Estate Fund: As a strong distinction, Real Estate Funds invest in securities of companies in the real estate sector. They help a real estate company to develop property and complete projects. If the sector does well, the profits are good.

3. Funds for Distressed Assets: It is a scheme to help the MSME sector recover and grow. It has a sub-debt facility for the promoters of the MSMEs that are distressed or non-performing assets(NPA). A credit guarantee cover of Rs 20,000 crore will be provided to the MSMEs. They can borrow this from the banks and invest in their units as equity.

4. Debt Fund: This fund significantly invests in debt instruments of listed and unlisted companies. Companies with low credit score release high-yield debt securities. Investors find it viable to help companies that have good business practices and high growth potential but face a cash crunch. SEBI disallows these funds from giving loans.

5. Fund of Funds: It is in effect a combination of various Alternative Investment Funds. It primarily invests in other AIFs instead of creating its own portfolio. A clear distinction is Fund of Funds under AIFs cannot distribute units like Fund of Funds under Mutual Funds.

Alternative Investment Funds

Category 3

These funds use diverse trading strategies and invest in listed and unlisted companies. They subsequently use arbitrage, derivatives trading, futures, etc. They are of close-ended and open-ended types. Less regulated in comparison to conventional instruments. The government of India does not provide any concession on these funds.

Following sub-categories are,

1. Hedge Funds: They consequently invest in domestic and international markets by pooling the money from private investors. They use a lot of trading and investing strategies to invest the collected funds. They typically hold positions in long and short regular instruments. In addition to this, they hold positions in listed and unlisted derivatives. They borrow up to 200% of the fund size. Expensive as the management team charges a 2% fee as well as a 20% share in profits.

2. Private Investment in Public Equity:  The fund managers buy shares of publicly traded companies at discounted prices. This subsequently helps businesses to pump capital into their enterprise. Regulations for funding of the business through PIPE are less in comparison to the secondary issue. Medium and small businesses can fund their business with ease through PIPE. They also require less paperwork as compared to secondary issues.

Who should invest in Alternative Investment Funds? 

Resident Indian nationals, Non-resident Indians, and Foreign nationals can invest in AIFs. In addition this there is a cap on investment for every investor. The minimum investment amount is Rs 1 crore while managers, employees of the AIFs can invest Rs 25 lakhs. The fund mandates the total number of investors as 1000 while Angel Funds have only 49 as a requirement. The minimum Lock-in period is 3 years.

Those investors who meet the above criteria can invest in AIFs.

Alternative Investment Funds Taxation

15% or 10% tax is deducted for Category 1 and 2 investments as per the holding period. 42.7% tax is charged for Category 3 funds.

Alternative Investment Funds

Alternative Investment Funds vs Mutual Funds

Mutual Funds are investment vehicles for retail investors. AIF are investment vehicles for sophisticated, high net worth investors and are segregated accordingly by the SEBI.

AIFs are slightly aggressive as they go for high yield by complex trading strategies and often short-sell as per the situation in contrast to Mutual Funds which are unable to do so.

Click here to know more about different types of Mutual Funds.

Who is the Sponsor of Alternative Investment Funds?

A person who has set up the AIF is its sponsor. In the case of a company, the promoter is the sponsor and in the case of an LLP, the designated partner is the sponsor.

Conclusion

Undoubtedly, Alternative Investment Funds are an attractive investment option for high net worth individuals. All in all, they use complex trading strategies to maximize their returns and are different than Mutual Funds.

Generally, AIFs are classified under three categories by SEBI, Category 1, 2, and 3. Category 1 and 2 enjoy concessions and benefits from the government of India as they contribute to the growth of the Indian economy, create jobs, and help businesses flourish. The category does not enjoy such an incentive as it is focused on debt and equities.

Want to Invest in Alternate Investment Funds?
Enter your details and request a FREE ADVISORY CALLBACK

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