Investment Funds with Non-Traditional Strategies Explored
Investing in Alternative Investment Funds (AIFs) in India offers distinct benefits based on their investment focus, regulatory treatment, and risk-return profiles. AIFs are privately pooled investment vehicles that invest in alternative asset classes such as private equity, venture capital, hedge funds, real estate, commodities, and derivatives.
Category I AIFs
Category I AIFs invest in sectors with positive social or economic impact such as startups, infrastructure, and social ventures. These funds receive government incentives and are aimed at promoting economic growth and job creation, making them attractive for investors interested in long-term, impact-driven investments. Income from Category I AIFs enjoys a "pass-through" tax status, meaning investors are taxed at capital gains rates (12.5% as per the Union Budget 2025-26), avoiding fund-level taxation except for business income.
Category II AIFs
Category II AIFs invest mainly in private equity and debt instruments focusing on corporate growth across various stages. While these do not get direct government incentives, they play a critical role in financing private companies and offer access to high-growth unlisted assets with potentially higher returns. Similar to Category I, they benefit from the pass-through tax regime with capital gains taxed at 12.5%.
Category III AIFs
Category III AIFs involve higher-risk, high-return investment strategies including leveraging and derivatives trading. They offer more flexibility, especially for short-term trades and advanced strategies. However, unlike Categories I and II, Category III funds are taxed at the fund level according to applicable tax rates instead of the pass-through provision, which may affect after-tax returns.
Eligibility and Investment Requirements
Indian Residents, NRIs, and foreign nationals are eligible to invest in AIFs, with a minimum investment amount of Rs1 crore for investors and Rs 25 lakh for directors, employees, and fund managers. Most AIFs come with a minimum lock-in period of three years and the maximum number of investors in every scheme is capped at 1,000, except for angel funds which have a cap of 49.
Risks and Due Diligence
AIFs are risky investments, as their investments in non-traditional assets like private equity or hedge funds may be more volatile and complex. It is important to carefully weigh the risks and conduct extensive due research before investing in AIFs.
Popularity and Growth
These combined advantages explain the rapid growth and increasing popularity of AIFs in India’s investment landscape. AIFs provide access to diverse non-traditional assets such as unlisted companies, pre-IPO deals, real estate, and special situation investments not available through public markets. They are managed by professional teams using innovative strategies to balance risk and return, and offer structured benefits such as hurdle rates, profit waterfalls, and co-investment rights. These features make AIFs particularly appealing to high-net-worth individuals, family offices, and institutional investors seeking higher returns with controlled risk over longer lock-in periods (Categories I and II) or flexible trading (Category III).
1.Equity funds, such as those found in Category II AIFs, invest mainly in private equity and debt instruments, offering access to high-growth unlisted assets and the potential for higher returns.2.Investors interested in long-term, impact-driven investments might find Category I AIFs appealing, as they invest in sectors with positive social or economic impact and receive government incentives.3.For those seeking more flexible, short-term investments with potentially higher returns, Category III AIFs with leveraging and derivatives trading strategies could be a good fit; however, these funds are taxed at the fund level, which may impact after-tax returns.
