Should You Invest in Alternative Investment Funds

Investing is no longer limited to just stocks, mutual funds and fixed deposits. With the changing nature of markets and more informed investors, several are seeking newer asset classes to diversify and earn more returns. Alternative Investment Funds (AIFs) are one such option that is increasingly becoming popular in India.

But should you invest in them? Do they suit all? This blog will talk about AIFs, how they work, their types, pros, risks and who should consider investing in them.

 

What Are Alternative Investment Funds?

Alternative Investment Funds (AIFs) are investment funds privately owned that invest in non-traditional assets, like stocks and bonds. These are the private equity, hedge funds, venture capital, real estate, and other structured products.

AIFs are SEBI (Securities and Exchange Board of India)-registered and can either be high-net-worth citizens (HNIs) or institutional investors.

 

Types of AIFs in India

SEBI divides AIFs into three general categories:

 

1. Category I AIFs

Such investments in start-ups, small and medium enterprises (SMEs) and areas that are deemed socially or economically desirable.

Examples: social impact fund, SME fund, venture capital fund.

 

2. Category II AIFs

They are private equity funds and debt funds that do not leverage or borrow except to operate.

Examples: real estate funds, private equity funds.

 

3. Category III AIFs

These are designed to produce short-term returns using complex trading rules. They are leveraged and usually risky.

Examples: Hedge funds.

 

Who Can Invest in AIFs?

Not all retail investors are eligible to invest in AIFs. They are aimed at advanced investors who can take on more risk and meet the minimum investment requirement.

Minimum Investment:

₹1 crore (excluding employees/directors of the fund)

These investments typically fit HNIs, family offices, corporate treasuries, or individuals with a high level of financial savvy and a high risk profile.

 

Why Are Investors Considering AIFs?

As people are becoming more aware and are willing to fight inflation and market volatility, a larger number of investors are considering AIFs. Here are a few reasons why:

 

 1. Diversification: AIFs provide an opportunity to invest in resources that are not typically offered by other investment vehicles, such as mutual funds and stocks. This will enable you to grow your portfolio differently.

 

 2. High-return potential: Since they are investing in early-stage businesses or even real estate, certain AIFs can return at a much higher rate than traditional investments.

 

3. Professional Management: AIFs are run by professional fund managers who employ thorough research and proactive investment strategies to achieve maximum returns.

 

4. Access to Privately Traded Markets: AIF's ability to buy and sell privately owned companies and industries that cannot be listed on public markets can be very lucrative over time.

 

Risks of Investing in AIFs

Though AIFs can be beneficial, they are less safe than traditional investments. One should learn about them before investing.

•  Illiquidity: AIFs are often locked up for several years (usually 3 to 7 years). Unlike mutual funds, you cannot withdraw your money at will.
• More risky: Investing in unlisted companies or start-ups can be risky. There is also the risk of capital loss, particularly in complex strategies of AIFs of the third type.
• Transparency: Not all data about AIFs are publicly available, as is the case with mutual funds. We have to trust the fund manager and his strategy and experience.
• High Entry Barrier: Only rich investors can invest in AIFs due to the minimum investment requirement of Rs. 1 crore.

 

Taxation on AIFs in India

AIFs are taxed in the following categories:

• AIFs category I and II: Income (capital gains, interest, etc.) is taxed by investors. The investment is normally transferred to the investor by the fund.
• Category III AIFs: The fund is taxed at the most marginal rate at the fund level, which may decrease returns.

You should also make appointments with a tax advisor to inquire about the tax implications before investing in AIFs.

 

Should You Invest in AIFs?

Here is a basic checklist to assist you in making a decision:

Consideration

• Can you invest Rs.1 crore or more?
• Do you already have a well-diversified portfolio?
• Do you feel comfortable with extended lock-in?
• Are you able to deal with increased risk and losses?
• Do you want exposure to reduced market privacies or different strategies?

If you answered most of the above questions with Yes, AIFs can be considered with the assistance of a financial advisor. Otherwise, it may be safer to remain with mutual funds, ETFs, and other regulated choices.

 

Final Thoughts

Although not everyone can invest in Alternative Investment Funds, they can provide a very special opportunity to investors who have a greater risk appetite, a long-term outlook and enough capital. They have access to markets and strategies that are not accessible using traditional investments.

But they need to know well the risks, taxation and the long-term commitment. When considering AIFs, make sure you do your research carefully, meet with a financial advisor, and make sure that they fit into your overall financial plan.