Exploring Alternatives: A Journey into Alternative Investment Funds (AIFs)

Mon, 3 Jun 2024

5 min read

An Alternative Investment Fund (AIF) refers to a privately pooled investment vehicle that operates outside of traditional investment markets such as stocks, bonds, and cash. These funds typically invest in assets such as real estate, private equity, hedge funds, commodities, infrastructure, and other alternative asset classes.
 

• Types of AIFs

  In India, Alternative Investment Funds (AIFs) are classified (as per SEBI) into three categories based on their investment strategies, risk profiles, and other characteristics. Types of AIFs are:
  
  Category I AIF: 
  These funds invest in start-ups, early-stage ventures, social ventures, small and medium-sized enterprises (SMEs), infrastructure, or other areas that the government or regulators consider socially or economically desirable. They are generally considered to have low risk and can include venture capital funds, SME funds, social venture funds, and infrastructure funds. Some of the funds are:
  
  1. Venture Capital Funds: Venture capital funds invest in early-stage and growth-stage companies with high growth potential. These funds provide capital and strategic support to startups in exchange for equity ownership, with the goal of realizing substantial returns upon successful exits through acquisitions or initial public offerings (IPOs).
  
  2. Infrastructure Funds: Infrastructure funds invest in assets such as transportation, energy, utilities, telecommunications, and social infrastructure projects. These funds typically seek stable, long-term cash flows generated by essential infrastructure assets.
  
  3. Social Ventures: Category I AIFs may focus on investing in businesses or projects that have a positive social or environmental impact, such as healthcare, education, renewable energy, affordable housing, and microfinance. These investments seek to generate both financial returns and social or environmental benefits.
  
  Category II AIF:
  Category II AIFs typically do not undertake leverage or borrowing other than to meet day-to-day operational requirements. These funds may include:
  
  1. Private Equity Funds: Funds that primarily invest in unlisted companies, either in the form of equity or equity-linked instruments, with the objective of providing capital for growth, expansion, or buyout purposes.
  
  2. Debt Funds: Funds that primarily invest in debt securities such as bonds, debentures, and other fixed-income instruments. These funds may focus on various types of debt, including corporate debt, government securities, structured debt, and distressed debt.
  
  3. Infrastructure Funds: Funds that invest in infrastructure projects such as transportation, energy, utilities, telecommunications, and social infrastructure. These funds may provide capital for the development, construction, or operation of infrastructure assets.
  
  4. Real Estate Funds: Funds that invest in real estate properties such as residential, commercial, industrial, and retail properties. These funds may focus on various real estate strategies, including rental income, development projects, and opportunistic investments.
  
  5. Other Asset Classes: Category II AIFs may also include funds that invest in other asset classes such as commodities, derivatives, structured products, and special situations.
  
  Category III AIF:  
  These funds are characterized by their ability to employ diverse trading strategies, including leveraging or borrowing, to potentially enhance returns. Category III AIFs often engage in high-risk activities such as derivatives trading, short selling, and speculative investments. Some of the funds are:
  
  Hedge Funds: Hedge funds aim to generate returns by employing a wide range of investment strategies, including long and short positions in various asset classes, derivatives trading, and leveraging techniques. They often have flexible investment mandates and may focus on absolute returns rather than benchmark-relative performance.
  
  A Private Investment in Public Equity (PIPE) Fund refers to an investment vehicle that provides capital to publicly traded companies through the purchase of equity or equity-linked securities in private transactions. PIPE transactions allow companies to raise capital quickly and efficiently by selling securities to accredited investors, institutional investors, or private equity funds.

• Who Can Invest in an AIF?

  Investors seeking portfolio diversification may consider investing in AIFs provided they meet the following eligibility requirements:
  
  •    AIFs entail a minimum lock-in period of three years.
  •    Residents of India, NRIs, and foreign nationals are eligible to invest in these funds.
  •    The minimum investment threshold for investors is Rs. 1 crore. 
  •    The number of investors in every scheme is restricted to 1000, except angel funds, where the number of investors goes up to 49.
  •    Institutional Investors: Entities such as banks, insurance companies, pension funds, endowments, and sovereign wealth funds may invest in AIFs.
  •    Qualified Institutional Buyers (QIBs): Institutions that meet certain financial criteria and are deemed qualified by regulators, such as SEBI in India or the SEC in the United States, may invest in AIFs
  •    Corporate Entities: Companies, partnerships, trusts, and other corporate entities may invest in AIFs either directly or through their investment vehicles.
  •    Foreign Investors: Depending on the jurisdiction and regulatory framework, foreign investors, including foreign individuals, institutions, and entities, may be allowed to invest in AIFs.

• Why Consider AIFs?

  Diversification: AIFs offer exposure to non-traditional assets like private equity, real estate, and commodities, reducing portfolio risk.
  
  Potential for Higher Returns: AIFs may outperform traditional investments due to their active management style.
  
  Risk Management: AIFs use sophisticated strategies to manage risk, protecting investors from market volatility.
  
  Innovation: AIFs can invest in innovative sectors and strategies that are not accessible through traditional investments.
  
  Expert Management: AIFs are managed by seasoned professionals with deep market knowledge and expertise.
  
  Regulatory Oversight: AIFs are regulated by securities regulators, ensuring transparency and investor protection.

• Taxation on AIFs:

  The tax treatment for investors in AIFs depends on the category of the AIF and the nature of the income earned by the AIF:
  
  AIF category I / II which invest in unlisted securities (bonds or equity) are pass through vehicles and tax is charged at investor level. The rate and slab of tax is dependent on the nature of income earned by the AIF.
  
  1. Capital Gains: Profits derived by selling unlisted equity held as capital assets are taxed as capital gains. Short-term capital gains (STCG) are taxed at the applicable slab rates, while long-term capital gains (LTCG) are taxed at 20% with indexation benefits.
  Interest Income: If the AIF generates interest income periodically, it is taxable in the hands of the investors based on their respective tax slabs.
  
  2. Dividend Income: Dividends received by AIFs from underlying investments are taxed at investor level depending on overall dividend income.
   
  AIF category III which invest in Listed securities (primarily equities and derivatives) are generally taxed at the Fund level. The rate and slab of tax is dependent on the nature of income earned by the AIF.
  
  1. Capital Gains: Profits derived by selling equity held as capital assets are taxed as capital gains. Short-term capital gains (STCG) are taxed at 15%, while long-term capital gains (LTCG) are taxed at 10% on profit.
  
  2. Income from Derivatives: the income generated from derivatives transactions are taxed as business income as per tax slabs.
  Dividend Income: Dividends received by AIFs are taxed as per tax slabs
   

• To Bring It to a Close

  At InCred Premier, we acknowledge that your hard-earned wealth deserves nothing less than the utmost care and attention. Rest assured, we are committed to providing you with unparalleled investment services.
  
  If you need help or have any questions as you progress, our dedicated team is here for you. You may reach out to us at care@incredpremier.com