What are the Types of AIFs and Their Investment Strategies

With years of evolution, many people still invest in mutual funds, stocks, and bonds. On the other hand, you may have heard of people investing in startups, private equity deals, or hedge funds, and also wondered how they got in.

That's where Alternative Investment Funds (AIFs) come into the picture. Think of them as exclusive investment pools designed for investors (HNIs and Ultra HNIs) who want to go beyond the usual and tap into high-growth opportunities.

Stay tuned as we delve into the different types of AIFs in India, the investment strategies adopted by AMCs (Asset Management Companies), and how, where, and how much to invest.

Curious how the AIF fund invests your money? You'll see in a moment.

What Are Alternative Investment Funds?

Alternative Investment Funds (or AIFs) are privately pooled investments from investors, which are later invested in – private equity, venture capital, debt funds, real estate, hedge funds, and other trading strategies. But, you should also know that: "AIFs are not for retail investors."

As per the SEBI regulations, 2012, Alternative Investment funds allow only high-net-worth individuals and Ultra HNIs to invest with exclusive (additional capital). Hence, the minimum corpus limit of AIF is ₹1 crore. For Angel funds, it is ₹25 lakhs.

Likewise, if the manager, employee, or director of the AIF fund wants to invest, the minimum investment required is ₹25 lakhs.

Types Of AIFs And Their Investment Strategies

In total, there are three major types of AIFs available in India. It includes - Category 1, Category 2, and Category 3 AIF. And remember, each AIF type has its own structure and investment strategy to implement.

Category I AIF

It invests in funds that focus on “Startups, Infrastructure Projects, Early-Stage Ventures, And Socially/Economically” beneficial areas.

Examples:
Venture Capital Funds - Investment in high-potential startups in their early journey.
Social Venture Funds - investing in businesses with a social impact mission.
Angel Funds - pooling investments from angel investors to support new ventures.
Infrastructure Funds - Focus on large-scale infrastructure projects.
SME Funds - Here, the fund focuses on scaling up small and medium-sized enterprises.

Investment Strategy:
It primarily deals in Unlisted securities.
The minimum investment is ₹1 crore and ₹25 lakhs for Angel funds.
According to SEBI guidelines, any AIF fund must have a minimum investment of ₹20 crore. For the angel fund, it is ₹10 crores.
No scheme holding more than 1,000 investors. For the Angel fund, only 49 investors are allowed.
For investors, the minimum lock-in period is 3 years, followed by a 5-year extension (with 2/3rd approval of unit holders by their investment value).
Cat 1 AIF can invest in the units of other types (AIF I and II) of the same sub-category. For example, ABC venture capital fund (of Cat I) can invest in units of XYZ infrastructure fund.
The AMC can only invest up to 25% of its investable funds in a single company. For large-value funds, the limit is up to 50%.

Category II AIF

These AIFs invest in equity and debt securities of listed/unlisted companies. Strictly speaking, they do not undertake leverage or borrowing, except to meet daily requirements.

Examples:
Private Equity Funds – Invest in unlisted companies or take ownership stakes to help them grow.
Real Estate Funds – Pools money from investors to further invest in residential or commercial real estate projects.
Debt Funds – Provide structured loans or credit to companies instead of equity ownership.
Funds for Distressed Assets – It buys stressed or bankrupt company assets at a discount and tries to revive them.
Fund of Funds (FoF) – They don't invest directly in companies, but in other AIFs or investment funds.

Investment Strategy:
The same rules of Cat 1 AIF apply to Category 2 AIF as well.
Valuation of the Alternative investment fund must occur at least once every 6 months, subject to extension.
Qualified Institutional Buyers (QIBs) have no lock-in (if held for 1 year prior to IPO).

Category III AIF

Following a close-ended fund type, this AIF invests your money in complex or diverse trading strategies, including listed and unlisted derivatives.

Examples:
Hedge Funds - Use advanced strategies like leverage, derivatives, and arbitrage to generate high returns - often in both rising and falling markets.
PIPE (Private Investment in Public Equity) Funds - Invest directly in publicly listed companies by buying shares at discounted prices.
Structured Credit Funds - Lend to businesses through complex instruments (like mezzanine debt or securitized products) to earn higher yields.
Long-Short and Long-Only Strategies -
Long-Short: Buy stocks expected to rise and short-sell those likely to fall.
Long-Only: Buy and hold stocks with growth potential, without short-selling.

Investment Strategy:
Unlike Cat I & II, Category III AIFs generally do not have a mandatory lock-in. It depends on the fund whether its open-ended or closed-ended.
The Cat 3 AIF can borrow or leverage up to 2 times the NAV of the fund (within limits set by SEBI) to amplify returns.
Investment in a single company is capped at 10% of its investable funds. For Large-value funds (LVFs), it is up to 20%.

Key Differences Between the Categories

The table below gives a simple classification of the different types of Alternative Investment Funds.

Conclusion

The purpose of bringing AIFs is to step into a world beyond mutual funds and bonds. With the different types available, you can invest in private equity, real estate funds, venture capital, hedge funds, and much more. But, before investing, you must read the fund's PPM (Private Placement Memorandum) and find out where they intend to invest.

[Disclaimer: The information provided in this article is for educational and informational purposes only. Any financial figures, calculations, or projections shared are solely intended to illustrate concepts and should not be construed as investment advice. All scenarios mentioned are hypothetical and are used only for explanatory purposes. The content is based on information obtained from credible and publicly available sources. We do not guarantee the completeness, accuracy, or reliability of the data presented. Any references to the performance of indices, stocks, or financial products are purely illustrative and do not represent actual or future results. Actual investor experience may vary. Investors are advised to carefully read the scheme/product offering information document before making any decisions. Readers are advised to consult with a certified financial advisor before making any investment decisions. Neither the author nor the publishing entity shall be held responsible for any loss or liability arising from the use of this information.]