Alternate Investment Funds

Alternate Investment Funds

by Tanushree Jaiswal Last Updated: May 26, 2023 - 01:55 pm 1.3k Views
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Introduction

Alternate Investment Funds (AIFs) are a type of investment mechanism that pools funds from affluent individuals and institutional investors to invest in assets that are not accessible through standard investing channels, such as equities and bonds. AIFs are often run by experienced fund managers who invest in various alternative assets, such as commodities, infrastructure, hedge funds, private equity, and real estate.

For high-net-worth individuals and institutional investors seeking to diversify their portfolios and provide greater returns than standard investing options, AIFs are a popular investment choice. AIFs are subject to Securities and Exchange Board of India (SEBI) regulations and must adhere to stringent investment and disclosure standards. AIFs allow investors to engage in specialized industries and assets that are inaccessible through conventional investment channels. AIFs invest in alternative assets, which are less liquid and have a significant risk-return profile than conventional investment options. As a result, investing in AIFs has a higher level of risk.

What are Alternate Investment Funds (AIFs)? 

Alternative investment funds are investment vehicles that pools money from high-net-worth individuals and institutional investors. Alternative investment funds meaning is that it allows investors to diversify their portfolios and earn higher returns than conventional investment options. Experienced fund managers typically handle them. However, because AIFs invest in alternative assets, which are less liquid and have a higher risk-return profile, there is also a higher level of risk when investing in them.

How Do Alternate Investment Funds Work?

Alternative Investment Funds are often run by experienced fund managers that invest the pooled funds in various alternative assets, including commodities, real estate, infrastructure, commodities, hedge funds, private equity, and real estate. The fund manager bases their judgements on the AIF's investment objectives and strategy.

SEBI regulates AIFs, which can be set up as a trust or a company. AIF investors often need to be high-net-worth individuals and make a minimum investment. The investors receive returns from the AIFs in proportion to their initial investments. Due to the volatile nature of the alternative assets they invest in, AIFs carry a higher level of risk than conventional investing options. To safeguard investors and maintain transparency, AIFs are also subject to several limitations and rules. Before making an investment choice, investors should carefully weigh the risks and rewards of AIFs.

Types of AIFs Found in India


Category 1 

Category 1 AIFs invest in infrastructure, SMEs, social ventures, start-ups, and early-stage businesses. These AIFs encourage entrepreneurship and innovation and have a favorable effect on the economy.

Category 1s' subcategory:

●    Venture Capital Funds (VCFs): Investments in start-ups, early-stage businesses, and businesses with significant growth potential are made through venture capital funds (VCFs).
●    SME Funds: Invest in small and medium-sized businesses through SME funds.
●    Social Venture Funds: Invest in social enterprises to produce a positive social impact and financial rewards through social venture funds.
●    Infrastructure funds: These funds invest in infrastructure projects, including highways, ports, and airports, intending to give investors a long-term capital gain.

Category 2 

Funds that do not come under Category 1 or Category 3 are categorized as Category 2 AIFs, defined as those that use complicated or varied trading techniques and may use leverage, such as through investments in listed or unlisted derivatives. These AIFs are for investors who are prepared to assume more risks in exchange for better profits.

Category 2 AIFs' subcategory:

●    Debt Funds: Bonds, debentures, and other debt securities are among the financial instruments in which debt funds might invest.
●    Fund of Funds: Invest in other AIFs to give investors diversification.
●    Hybrid Funds: Invest in a mix of stock, debt, and other instruments using hybrid funds.

Category 3 

AIFs in Category 3 use sophisticated trading techniques and may borrow money or use leverage. These AIFs are for investors prepared to take on large risks in exchange for bigger profits.

Category 3 AIFs' subcategory:

●    Hedge Funds: These funds invest in various assets and produce returns using cutting-edge strategies, including short-selling and derivatives.
●    Private equity funds: Invest in privately held businesses to increase investor capital through expanding these businesses.

Who Can Invest in Alternative Investment Funds (AIFs)?

Professional and institutional investors that satisfy specific requirements may invest in Alternative Investment Funds (AIFs). Individuals with a minimum net worth of Rs. 2 crores or who earn at least Rs. 25 lakhs per year fall under this category. Alternative Mutual Funds are also open to institutional investors like banks, financial institutions, and insurance companies.

AIFs are not open to retail investors or those who don't fit the eligibility requirements. It is because AIFs invest in alternative assets, which are riskier and more complex than traditional investments. As a result, understanding the risks and returns of these investments requires a higher level of financial education.

Why Invest in AIFs?

The possibility for increased returns and portfolio diversity are only two advantages of investing in alternative investment funds (AIFs). Higher returns and a lower overall level of risk for the investment portfolio are both possible results of this. Professional fund managers with the knowledge and resources to find and invest in opportunities that might not be available to individual investors also manage AIFs. However, investing in AIF alternative investment funds also carries a higher level of risk, so investors must carefully weigh the risks and profits before making a decision.
 

Advantages and Disadvantages of Alternative Investments

Pros

Explanation

Cons

Explanation

Diversification

Alternative investments provide exposure to assets that are not correlated to traditional investments, such as stocks and bonds.

Higher risk and illiquidity

Alternative investment funds can be riskier and less liquid than traditional investments.

Higher returns

Alternative investments can offer higher returns than traditional investments.

Complexity

Alternative investments can be complex and require a higher level of understanding and expertise than traditional investments.

Access to unique opportunities

Alternative investments offer access to opportunities not available in traditional investments, such as real estate, hedge funds, and private equity.

Higher fees

Alternative investments often have higher fees, such as management fees and performance fees, compared to traditional investments.

Inflation hedge

Certain alternative investments, such as real estate and commodities, can act as a hedge against inflation.

Limited regulatory oversight

Alternative investments may be subject to less regulatory oversight than traditional investments.

 

How to Invest in Alternative Investments?

The following ways can help you invest in alternative investment funds:

●    Choose the alternative investment strategy that best matches your investment objectives and risk tolerance.
●    Ascertain your suitability for making alternative investment opportunities.
●    Conduct an in-depth investigation and due diligence on the investment possibility.
●    Recognize the expenses and fees related to investing in alternative assets.
●    Consult a qualified counsellor or investment company that knows alternative investments.

Tax Benefits of AIFs

Alternative investment funds are categorized as pass-through entities for taxation purposes, meaning the tax burden is transferred to the investors. The following are a few tax advantages of AIF investment:
●    Lower tax rates: Depending on the form of AIF, the long-term capital gains tax on AIFs is either 10% without indexation or 20% with indexation.
●    Tax deductions: Tax deductions are available for investments made in specific types of AIFs, such as infrastructure funds, under Section 80C of the Income Tax Act.
●    Tax exemption: Under certain conditions, foreign investors' income from specific categories of AIFs is excluded from Indian taxation.

Conclusion

Alternative Investment Funds (AIFs) provide investors with various investment choices outside more conventional ones like stocks and bonds. AIFs may provide advantages, including diversification, higher returns, and special possibilities, despite their increased risks and fees. Before purchasing AIFs, investors should carefully consider their risk appetite and investment objectives. They should also speak with a qualified advisor to make the best choice possible.

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About the Author

Tanushree is a seasoned professional with 6 years of experience in the Fintech and Edtech industry.

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