All you wanted to know about the Alternate Investment Funds

Alternative Investment Fund (AIF) refers to a privately pooled investment vehicle established or incorporated in India. It is designed to collect funds from sophisticated High Networth Investors(HNI, UHNI), both domestic and foreign, who possess significant capital to invest, for investing in accordance with a defined investment policy, for the benefit of its investors.

It is important to note that AIFs do not fall under the purview of SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999, or any other regulations of the Securities and Exchange Board of India (SEBI) that regulate fund management activities.

The AIF Regulations provide certain exemptions from registration to family trusts set up for the benefit of ‘relatives’ as defined under the Companies Act, 1956, employee welfare trusts, gratuity trusts set up for the benefit of employees, ‘holding companies within the meaning of Section 4 of the Companies Act, 1956, and other entities as specified in the regulations.

If you’re seeking investment options beyond conventional choices like stocks, bonds, and cash, alternative investment funds (AIFs) can be a viable option. alternative investment funds typically offer higher returns than traditional options, albeit at a higher risk and a larger investment requirement.

Alternative Investment Funds

Different Categories of alternative investment funds (AIFs)

Category 1 

Alternate Investment Funds that invest in start-ups, SMEs and new economically viable corporations that have high growth potential. Category 1 AIF can only be close-ended. They include the following:

Infrastructure funds

These funding schemes primarily invest in companies that are engaged in infrastructural works like constructing railroads, airports, ports etc. Individuals who like to invest in infrastructural development generally invest in these types of funds. 

Venture capital funds (VCF)

Venture capital funds put their money into promising entrepreneurial businesses that have huge capital requirements. High net-worth individuals who have a high-risk high return policy usually invest in VCF.   

Angel funds

This type of alternative investment funds generally invests in new start-ups that do not receive investments from Venture capital funds. Each angel fund investor generally allocates minimum funding of Rs.25 lakh.

Social venture funds

Social venture fund schemes put their money in businesses that take part in philanthropic activities. They help people improve their standards of living and also provide good returns to their investors. 

Category 2

This category of AIF funds do not take debt for purposes other than daily operations, Category 2 AIF can only be close-ended and includes the following:

Debt funds

These funds invest in debt securities of unlisted companies that follow good corporate governance models and have decent growth potential. However, they are not for conservative investors as they have a low credit rating. 

Funds of funds

In the context of AIFs, a Fund of Fund refers to an AIF that invests in another AIF, allowing investors to gain exposure to a diverse range of alternative investments through a single investment vehicle.

Private equity funds

Private equity funds invest in unlisted private businesses that face difficulty in raising capital by issuing equity and debt instruments.  

Category 3

Category 3 can be both open and close-ended funds which may be leveraged and use advanced trading strategies, and include the following:

Hedge funds

Hedge funds collect money from investors and corporations in order to invest in debt and equity markets both on the domestic and international levels. These schemes follow an aggressive investment strategy to provide a higher return on investment for its investors. Moreover, they have a high expense ratio.

Private investment in public equity fund (PIPE)

This type of funding scheme invests in public firms by buying their shares at discounted prices. 

  1. Why Alternative Investment Funds (AIFs) are a Smart Investment Option

High Return Potential

AIFs offer a higher return potential than other investment options due to the large pooled amount and flexible investment strategies.

Fund managers have enough room to prepare strategies that maximise returns, making AIFs a profitable investment choice.

Security Against Volatility

AIFs are not directly related to stock markets, making them less volatile than traditional equity investments.

Investors who seek stability and security against market volatility may find AIFs suitable for their needs.

Excellent Portfolio Diversification

AIFs allow for diversification in an investment portfolio, providing a cushion during financial crises or market volatility.

Diversification is critical to minimise risks, and AIFs are an excellent option for investors who want to diversify their portfolios and achieve their financial goals.

  1. Minimum amount required to invest in Alternative Investment Funds(AIF)?

Investors are required to have a minimum investment of 1 crore when investing in AIFs. However, angel funds allow investors to participate with a minimum investment of Rs. 25 lakhs, making them a more accessible investment option for those who want to invest in startups or early-stage companies. And Rs. 25 lakhs for an employee, manager, or director of AIF.

  1. Total No.of Investors in a Scheme

Each scheme can have a maximum of 1000 investors. The number is limited to 49 when it is an Angel Fund.

  1. In which legal forms can an AIF be set up?

An AIF under the SEBI (Alternative Investment Funds) Regulations, 2012 can

be established or incorporated in the form of a trust or a company or a limited

liability partnership or a body corporate. Most of the AIFs registered with SEBI

are in trust form.

  1. Difference between MF vs AIF vs PMS
  1. Who is the Sponsor of the Alternative Investment Fund?

Sponsor is any person(s) who set up the alternative investment funds and includes a promoter in case

of a company and designated partner in case of a limited liability partnership

The sponsor/manager will maintain an ongoing interest in the AIF, which will not be in the form of a fee waiver. In Category I and II, the sponsor/manager must provide a contribution of at least 2.5% of the corpus or INR 5 crore, whichever is lower. In Category III, the contribution will be a minimum of 5% of the corpus or INR 10 crore, whichever is less. Angel investors must also contribute a minimum of 2.5% of the corpus or INR 50 lakhs, whichever is lower.

  1. Trustee

The trustee of a trust is permitted under the Trusts Act to invest the trust’s assets as per the terms of the trust deed. For an Alternative Investment Fund, the trustee may delegate considerable areas of its scope/powers (except those not permitted under applicable law) to the manager under the investment management agreement. Accordingly, the manager is entitled to make all investment decisions for and on behalf of the AIF.

  1. SEBI

The SEBI is the regulatory authority established under Section 3 of SEBI Act 1992 to protect the interests of the investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith and incidental thereto. 

  1. RBI

Regulator and supervisor of the financial system: Prescribes broad parameters of banking operations within which the country’s banking and financial system functions. Objective: maintain public confidence in the system, protect depositors’ interest and provide cost-effective banking services to the public.

  1. Commitment Amount

Committed capital is the amount of money that investors have committed to contribute to an investment fund over a specified period of time. This is the amount that the fund manager can count on to make investments and manage the fund’s operations. It is important to note that committed capital is not the same as actual capital contributed, as investors may contribute their committed capital over a period of time as called upon by the fund manager or based on certain milestones.

  1. Contribution Amount

Contribution amount refers to the sum of money that an investor is required to provide for investment in a particular fund or investment vehicle. This amount may be a one-time contribution or may be paid in instalments as per the terms of the investment agreement. The contribution amount may vary depending on the type of investment, the investment vehicle, the investor’s commitment, and other factors. Typically, the contribution amount is a key consideration for investors when deciding whether to invest in a particular fund or investment opportunity.

  1. Contribution Agreement

A contribution agreement is a legal document that outlines the terms and conditions of an investor’s commitment to contribute funds to a particular investment opportunity or vehicle. This agreement is typically signed between the investor and the investment vehicle, such as a private equity fund, venture capital fund, or other similar investment vehicle.

The contribution agreement will typically include details such as the contribution amount, the payment schedule, the rights and obligations of both the investor and the investment vehicle, the fees and expenses associated with the investment, the expected return on investment, the expected holding period, and any other relevant terms and conditions.

The purpose of the contribution agreement is to provide clarity and transparency to all parties involved and to ensure that the investment is made in a structured and organised manner. It also helps to protect the interests of the investor and the investment vehicle by clearly outlining their respective rights and responsibilities.

  1. PPM

PPM stands for Private Placement Memorandum, which is a legal document that is used by companies to disclose important information to potential investors in a private placement offering. A private placement offering is a securities offering that is made to a limited number of accredited investors who meet certain financial criteria, rather than being made to the general public.

The PPM is used to provide information to investors about the company’s business, financial performance, management team, and other key aspects of the investment opportunity. It may also include information about the terms of the investment, such as the investment amount, the expected return on investment, and any associated risks.

The purpose of the PPM is to provide potential investors with sufficient information to make an informed decision about whether to invest in the offering. It is also designed to help protect the company from potential legal liabilities by providing full and fair disclosure of all material information related to the investment opportunity.

  1. Hurdle Rate

Hurdle rate is a term used in finance and investment to refer to a minimum rate of return that an investment must achieve in order to be considered successful or to justify the associated risks. In other words, it is the minimum rate of return that an investment manager or investor expects to earn before any performance fees can be charged or incentive compensation can be paid.

  1. Management Fee

The AIF manager charges a management fee for their services, which must be disclosed in the AIF’s PPM. The AIF Regulations do not prescribe a specific format for charging the fee, but the manager can choose to charge a fixed or variable fee based on the AIF’s performance, or any other commercially appropriate manner agreed with the investors.

However, the manager cannot waive the fee to use it as the sponsor’s interest in the AIF. Closed-end AIFs typically charge management fees as a percentage of the total capital commitment of each investor during and after the investment period. The fee is computed separately for each investor to avoid any single investor being liable for the default, excuse or redemption by other investors.

  1. Operation and Administration Fees

In addition to the management fee, Alternative Investment Fund also charge operation and administration fees to cover various expenses related to the operation and administration of the fund. These fees are disclosed in the private placement memorandum (PPM) and may include expenses such as legal, audit, custodian, registrar and transfer agent, compliance, and other administrative expenses.

The AIF Regulations require that these fees should be reasonable and proportionate to the services rendered. The PPM should also disclose the estimated amount of such fees and the manner of computation. Investors should carefully review the PPM to understand the nature and extent of these fees and how they impact their returns.

Alternative Investment Funds
  1. Performance Fee

The performance fee is typically a percentage of the profits earned by the fund over and above a certain threshold, known as the “high-water mark.” The high-water mark is the highest value that the fund has reached in the past, and the performance fee is only charged on profits earned above this level.

The Performance Fee will be paid by the Fund to the Investment Manager. The Investment Manager, in its sole discretion, may waive or reduce the Performance Fee for a Contributor / Class / Sub-Class of Units. 

  1. Drawdown

Each Contributor shall pay a sum equal to Initial Contribution at the time of execution of Contribution Agreement or such other date as may be decided by the Investment Manager and the balance Capital Commitment shall be drawn down by the Investment Manager from time to time (‘Balance Contribution’). The drawdown process may occur over several rounds, and investors may be given notice of the timing and amount of each drawdown in advance. 

  1. Commitment Period

The commitment period is a period of time during which investors are obligated to provide capital commitments to an Alternative Investment Fund (AIF).

It typically begins at the start of the fund’s life and can last for several years.

Investors commit to providing a certain amount of capital to the AIF, but the capital is not transferred all at once.

Instead, the AIF manager calls capital as needed for investments through a process known as a drawdown.

The length of the commitment period can vary depending on the fund’s strategy and investment horizon, and is an important consideration for investors when evaluating an Alternative Investment Fund.

  1. Waterfall Distributions

Waterfall distributions are a method of distributing profits from an Alternative Investment Fund to investors based on a series of distribution priorities and thresholds. The structure is designed to align the interests of the fund manager and investors, incentivizing the manager to generate strong returns before taking a share of the profits. Specific terms are set out in the fund’s offering memorandum or other governing documents.


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When withdrawal can be made




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