Investments in a new way - Alternative Investment Funds (AIF)

An Alternative Investment Fund or AIF is an investment vehicle that privately pools investments from sophisticated investors, whether Indian or foreign, for investing according to a defined investment policy for the benefit of its investors. These funds are typically used by high-net-worth individuals and organisations since, unlike Mutual Funds, they require a sizable initial investment. AIF as a fund, is typically established or incorporated in India in the form of a Limited Liability Partnership (LLP) or Company or Trust or Body Corporate.[1] Incorporated in 2012 by the Securities and Exchange board of India, the market regulator's intent was to make equity markets more sophisticated for investors with a massive volume of wealth and distinct goals from the average Indian investor.

Alternative Investment

Investors are cautioned not to confuse AIFs with the following financial instruments:

Mutual funds, Collective investment schemes, Employee Stock Options Trusts, Employee welfare trusts or gratuity trusts, Family benefit trust, Holding companies

Categories of AIFs:

  1. Category I: AIFs that make investments in new start-ups, social enterprise funds, infrastructure funds, SME funds, and other similar entities are categorised as Category I AIFs [4]. They are frequently viewed by the government and authorities as being economically or socially feasible.

  2. Category II: Funds that don't borrow or use leverage for anything but meeting their operational needs, and don't fall under the category I or III are categorised as Category II AIFs [4]. Private equity funds, Debt Funds, and Fund of Funds are typical examples within this category.

  3. Category III: Funds in Category III engage in a variety of complicated trading strategies, such as investing in listed or unlisted derivatives [4]. Typically, hedge funds fall under this category. While closed-ended funds are categorised as Category I and II AIFs, open-ended funds are placed in Category III AIFs.

Requirements/ Eligibility Criteria of AIFs:

Each Alternative Investment Fund scheme (other than angel funds) must have a minimum corpus of twenty crore rupees. For an angel fund, the corpus must be at least ten crore rupees.

Any sophisticated investor, whether Indian, foreigner or non-resident Indian, who is willing to take on the risk of investing in largely unlisted or illiquid assets, may contribute money to an AIF. AIF (other than an angel fund) cannot accept investments from investors worth less than one crore rupees. The minimum amount of investment for investors who are AIF employees, directors of the AIF, Manager employees, or directors, shall be Rs. 25 lakhs [4].

Benefits of Investing in AIFs: 

  1. No correlation with Stock markets:
    “Don't put all your eggs in one basket”- Warren Buffet
    Anyone with a decent experience in financial planning and investments would believe in the above quote to diversify their portfolios. Taking it a step further, alternative investment funds provide us with an opportunity to invest in an asset class which is completely unhinged upon the dynamics of stock markets. Thus, making them less volatile even during times of economic distress.

  2. Tax Benefits:

Alternative investments provide tax benefits depending on the size and the asset the funds are invested in. You keep more of your profit thanks to the structure of many alternative investments. In many private alternative investments, you should be a member of the fund or syndicate, and the tax advantages are transferred straight to you. Pass-through depreciation and long-term capital gains treatment are the two major tax benefits. 

  1. Passive Investment Opportunities:

The majority of busy investors place a high value on their time, and actively managing an asset or portfolio requires considerable work. Hence these alternative investment funds like Real Estate funds are highly attractive options that provide an opportunity to passively invest in diverse asset classes, across suitable time horizons. 

  1. Customizable:

    An AIF's structure can be modified to suit a particular investment approach, such as sector exposure or asset class diversification, and moreover, the investor has the comfort to choose the product based on the time horizon for the investment.

Trends across the globe:

Although the term "alternative assets" is relatively new, investing in these kinds of assets is not a recent development and can be traced back to the Industrial Revolution in the 1800s. During the 20th century, alternative investments gained popularity, notably after the World Wars when many nations started to rebuild. Venture capital at this time evolved into the driving force behind achievement in the private markets. Due to the way that technology is altering many industries, venture capitalist investment in emerging technologies and business prospects has grown quickly.

The alternative assets industry has continued to grow in recent years and is now a mainstay of the modern investment landscape. The industry AUM is expected to reach $17.2 Trillion by 2025 with a CAGR of 9.8% from 2020. [2]

According to the SEBI data, the assets of the AIF business in India have increased by 42% in the financial year 2021-22, as more rich investors used these funds to minimise risk and maximise returns in their portfolios. From assets of Rs 80,000 crore, the industry has increased by more than 7 times in the last five years, with Category II funds dominating the field by contributing 80% of the AIF industry's assets. According to the Association of Alternative Investment Funds, over the next five years, AIFs might experience 3x growth and reach Rs 1.7 trillion in assets under management in India [3]. 

Conclusion:

In its truest form, the AIF structure serves as the model for dynamic asset management that exposes workers to high-calibre work. Working in such environments gives youngsters the opportunity to learn about the economy, markets, asset classes, and fostering business relationships. With growing financial literacy amongst Indian investors, the alternative assets classes are gaining traction for their low volatility and flexible investment options. Initial tax complications and concerns regarding the pass-through status of trusts pestered the growth of AIF when they were first launched in 2012, however, all of it has been fixed today. These lucrative funds are now all set to be characterised as the mainstream investment opportunity in India as well.

Sources/ References:

[1] Tax Guru

[2] Preqin

[3] Business Standard

[4] SEBI Regulations 2012

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