AIFs, or alternative investment funds, offer an alternative to traditional investment strategies. Compared to stocks, loans, and other similar securities, it is distinct.
Investors can invest in pre-planned, defined policies through the Alternative Investment Fund, a privately formed fund. These investors may be domestic as well as international, and private participation is used.
The approval and validation of alternative investment funds was triggered by the notification of the SEBI (Alternative Investment Funds) Regulations, 2012 ("AIF Regulations") on May 21, 2012. AIFs are subject to SEBI (Securities and Exchange Board of India) regulation, and such ventures are required to register. The funds can only be collected privately; a public call, like one for the issuance of shares, is not permitted.
According to the Regulation Act of SEBI, 2012, AIFs are governed. AIF are not subject to the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999, or any other Board regulations that govern fund management operations, despite the fact that they appear to be comparable to mutual fund models.
An AIF may be incorporated as a business, trust, LLP (Limited Liability Partnership), or even a body corporate and may take any legal form. The pattern shows that the majority of the AIFs that are now registered with SEBI were founded as trusts.
However, if the AIF has been incorporated as a business, then the Companies Act 2013 enters the picture and dictates the provision of the members. The Regulation Act only permits a maximum of 1000 investors. Additionally, the AIF cannot accept an investment of less than one crore rupees if it is soliciting money from its investor. Additionally, the minimum amount is Rs. 20 lakh if the investors are AIF employees or directors.
Let's now talk about the various AIF categories and how applicants can register themselves under them.
AIF can be divided into three main groups, which are detailed below.
CAT I
According to Regulation 3(4), category I consists of AIFs that put money from their private investors into start-ups, budding or early-stage businesses, or in other sectors where regulators or the government sees a potential for economic or social gain. Venture Capital funds, Angel funds, SME (small and medium-sized enterprises) funds, and infrastructure funds are a few sub-funds that fall under category I. Each sub-fund has a different lock-in term and minimum investment. The period during which investments cannot be sold or redeemed is referred to as the lock-in period. Some of these sub-funds have a particular condition that sets them apart from the others, such as a 10 year senior professional management role for angel funds or a 75 percent collective investment for SME funds.
CAT-III
Investments in Category III are regarded as open-ended. The investing strategy is diverse and includes both listed and unlisted derivatives. Simply expressed, the term "derivatives" refers to stocks, bonds, commodities, market indices, currencies, and interest rates. They are less regulated, and the government doesn't offer any discounts or other incentives for investing in these funds. Regulation 3(4) mentions these funds (c).
Hedge funds and PIPE (Private Investment in Public Equity) funds are the most popular forms of funds registered under Category III. Hedge funds generate high returns because they are exposed to greater market volatility or variability. Hedge funds are expensive because the management team receives a 20 percent profit share on top of fees of 19 percent of the investment. The money is invested in small and medium-sized firms through PIPE, or private investment in public equity. Due to the fact that these assets are not secondary investments like shares, there is less paperwork and control needed. They take less time and have less procedure than a firm issuing shares. The fund managers frequently purchase shares at a discount, aiding in the capitalization of the company.
CAT-II
Non-members of the aforementioned groups are referred to as category II funds. These funds are used to finance the operations of other firms, such as real estate funds, private equity funds, funds for distressed assets, funds for funds, etc. They are not used to purchase shares or borrow money. In Regulation 3(4), they are listed (b).
What modifications have been done to it?
A number of adjustments have recently been made to the regulation of alternative investment funds. The release of the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021 (Amendment Regulations) on May 5, 2021, brought about a number of significant changes and gave investors the freedom to be associated with multiple categories mentioned in the earlier section of the article. Additionally, a separate code of conduct was developed for the AIFs for better and more professional operation. Following the notice of May 5, 2021, there have been three significant changes, which are as follows:
A. Adaptable investment options
B. Investment committee's official recognition
Establishment of a different code of conduct flexible investments:
The most recent revisions allow AIFs to freely invest in other AIFs. AIFs previously had the option of investing in another AIF or an investee company. Since this segmentation has been removed, AIFs can now choose to follow both of these paths rather than strictly adhering to one or the other and being associated with them. However, in accordance with Regulation 9(2) of the AIF Regulations, there must be adequate disclosure pursuant to the Private Placement Memorandum (PPM) and with the permission of at least two-thirds of unit holders. If the AIF invests in another AIF, a list of information that must be disclosed in the PPM has also been mentioned. The inclusion of Non-Banking Financial Companies (NBFC) in venture capital projects is the second advancement. Only businesses engaged in the provision of goods or services or manufacturing were listed in the definition of a venture capital undertaking, which is a category I investment. But now non-banking financial institutions are now included in this definition, which has been expanded.
Recognizing the Investment Committee Officially
Although SEBI acknowledged the presence of investment committees with an amendment on October 19, 2020, recent developments have proven to be more empowering for AIFs. Investment committees have been appropriately engaged in assisting AIFs for their investment decisions and better functioning.
The new amendment mandates that the Investment Committee (IC) be mentioned in the AIFs Placement Memorandum. The investment committee and investment manager were formerly kept on a similar pedestal because of their ambiguous status. However, a separate structure has been developed to hold the investment committee accountable and provide it more independence.
In addition, the approval of 75% of investor members is needed if the committee members are hired externally and aren't listed in the placement memorandum.
Creation of a distinct code of conduct
These are listed under Regulations 20(1) and 20(9) of the Fourth Schedule to the SEBI (Alternative Investment Funds) Regulations of 2012. Like mutual funds, AIF is currently governed by a code of conduct that is broken down into different directives that executives at all levels are required to abide by. The code is intended for a variety of individuals who are either employed by or merely connected to the AIF. The purpose of the code of conduct is to:
- the AIF.
- The manager and the AIF's Key Management Personnel (KMP)
- The trustee/director/designated partners of the AIF, as well as the members of the IC.
The mutual fund code of conduct is similar to it in most ways. Transparency with investors is a crucial practise that the code of conduct supports. The rules stipulate that AIFs must routinely give investors access to important information and the fund papers that were promised in the Private Placement Memorandum. The code of conduct also outlines the responsibilities of managers and key managerial personnel (KMP), and it tends to set up a structure for resolving conflicts of interest amongst them.
Effects of those modifications
Together, these changes were necessary to improve the legitimacy and dependability of AIFs as an investment vehicle.
The ability to combine two categories has expanded the range of insurance products that AIFs can provide to their investors. Several definitions have changed, opening up new investing opportunities.
The ability to consider many viewpoints and communicate inside while making decisions has increased with the recognition of internal committees. The word "decisions of AIF" has been added to the regulation in place of the word "investment," significantly extending IC's authority and enabling it to make decisions regarding the operational activities of the relevant AIF. The above-mentioned 75 percent majority vote of the members is intended to promote peace and prevent any disagreement within the committee.
A distinct code of conduct improves the system's professionalism and work ethic. It was also a much-needed adjustment to maintain parity between mutual funds and AIF. The relationship between the manager and Key Managerial Personnel is also clarified by the code of conduct. Furthermore, KMP need not be a CEO, MD, or CIO; they might be someone with a similar capacity, according to the Fourth Schedule of the AIF Regulations. Such changes demonstrate the AIF's flexible operation and will attract the support of knowledgeable investors by earning their trust.
Conclusion
The Alternative Investment Policy Advisory Committee (AIPAC), led by Mr. Narayana Murthy in March 2015, was one of the committees that provided advice to SEBI regarding how to improve the operation of AIFs. The AIF is an underutilised investment vehicle, and SEBI has changed its focus over time by reforming its Regulation Act. With these proactive actions, SEBI preserves the investment sector a fertile platform for innovation. A lack of a code of conduct and the rigid adherence to the preexisting categories rendered AIFs unviable, necessitating reform. It's still a long way to go, but the cyclical submission of AIPAC reports in 2015, 2016 and 2017 attests to AIF's status as a developing investment platform. There has been a shift away from traditional investment methods, and a sincere effort on the part of the government to improve the efficiency of unconventional investment platforms helps to increase public acceptability of such endeavours.
