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Nuances Of Alternative Investment Funds

16 August 20226 mins read by Angel One
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As the name suggests, alternative investment differs from conventional investment instruments. Usually, non-institutional and HNI investors invest in alternative funds as the investment amount is high. Even if you are a budding investor, learning about the alternative investment funds in India will help you understand the market better. Let’s begin by asking, ‘what is an alternative investment fund?‘.

Alternative investment funds are defined in Regulation 2(1) (b) of India’s Securities and Exchange Board. By definition, it is a privately pooled fund in the form of a company, trust, body of corporate, or a Limited Liability Partnership (LLP). In a nutshell, an alternative fund doesn’t come under the jurisdiction of any regulator.

Types of alternative funds

A broad classification of AIF funds divides these instruments into three categories.

Category 1:

Funds registered under Category 1 primarily invest in start-ups, SMEs or economically and socially viable segments with high growth potential.

  • Venture capital funds
  • Angel funds
  • Infrastructure funds
  • Social venture funds

Category 2:

AIF funds in category 2 invest in private equity and debt funds without particular concession or incentive.

  • Private equity funds
  • Debt funds
  • Fund of funds

Category 3:

These funds invest in hedge funds or funds focusing on short-term returns which are typically open-ended.

  • Private investment in private equity funds (PIPE)
  • Hedge funds

All AIF schemes under categories 1 and 2 are close-ended. The tenure is determined at the time of initial investment but shouldn’t be less than three years.

Types of alternative investment funds

Category 1:

Venture Capital funds

Venture funds collect money from several investors who want to invest in ventures with high return possibilities. These funds invest in start-ups and new-age businesses with a higher growth probability.

Investing in venture funds involves high risk and high returns since these invest in new companies at an early stage. Each VC receives a share in the business proportionate to its investment.

Angel funds

These funds invest in budding start-ups, but they are not the same as VCs. Angel investors bring their management experience to the business and guide the start-up in the right direction. When the company takes off, each investor receives dividends against their investment.

An angel investor invests a minimum fund of Rs 25 lakh.

Infrastructure funds

These are specialised funds that invest in infrastructure development projects from railway construction to port construction. Investors bullish on infrastructure projects invest in these funds.

Social venture funds

Social venture funds invest in projects targeted to make social and environmental changes. Although it involves philanthropic activities, one can still expect returns from these investments.

Social venture funds lend managerial expertise, technological advancements, and experience to such projects, making them a profitable deal for the investors, the environment, and society.

Category 2:

Private Equity funds

The private equity funds invest in unlisted companies, which can’t tap funds from public investors. Usually, these funds have a fixed tenure of four to seven years, during which the firm is expected to generate handsome returns for the investors.

PE funds allow investors to diversify and minimise risks by spreading their funds.

Debt funds

Debt funds of category 2 of AIFs invest in debt funds of high credit risk debt instruments and unlisted companies. Usually, the money gets invested into companies with good governance and high growth potential.

As per SEBI guidelines, companies can’t use the pooled fund under AIF to lend directly to companies.

Fund of funds

As the name suggests, these AIF funds spread the investment in different alternative funds rather than making their portfolios.

Category 3:

Private Investment in Public Equity Funds (PIPE)

PIPE investors invest in publicly traded companies. Investing through PIPE mode is usually cheaper than buying shares in the secondary market because of the specially discounted rate. It also involves less paperwork and administration regulations.

Hedge funds

Hedge funds pool money from institutional and accredited investors to put in domestic and international equity and debt markets. Because they follow an aggressive investing strategy to generate high returns in the short term, the fund managers charge an asset management fee as high as 2 percent. There is also a 20 percent charge on returns levied on the hedge funds.

Benefits of investing in AIFs

AIFs offer multiple benefits to investors, some of which are,

High returns:

These funds are designed to generate high returns for investors. Because of the increased availability of funds, AIF fund managers can deploy aggressive investment strategies for higher returns.

Low volatility:

Despite being aggressive, AIFs are relatively low in volatility because they are not directly related to the stock market.


Alternative investment funds are excellent for portfolio diversification, and because of low volatility, these funds offer a cushion when the financial market is volatile.

Who can invest?

HNI investors, Indian, foreign, and non-resident investors can invest in AIF funds. However, they need to fulfil the following eligibility criteria.

  • The minimum investment amount is Rs 1 crore for general investors and Rs 25 lakh for directors, employees, and fund managers.
  • AIFs in categories 1 and 2 come with a minimum lock-in period of three years.
  • The number of investors in each fund is restricted to 1000, except for Angel Funds, where the number can go up to 49

Risks of AIFs

Here are the risks that investor needs to know.

  • Liquidity and the lack thereof
  • High leverage
  • Valuation risk
  • Market risk
  • Lack of regulation
  • High fees

Final words

AIF funds are high return, low volatility investment options. If you have a substantial investable corpus you want to invest in high return schemes, these are excellent options to amplify your profit potential and diversify your portfolio. We recommend that you evaluate all the options available based on your financial goals and risk appetite before committing.

Disclaimer: Angel One Limited does not endorse investment and trade in cryptocurrencies. This article is only for education and information purposes. Discuss with your investment advisor before making such risky calls.

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