ALTERNATIVE INVESTMENT FUND

Alternative Investment Funds (AIFs) represent a category of collective investment funds that engage in diverse investment strategies, encompassing alternative assets including venture capital, real estate, private equity, hedge funds, and managed futures. Diverging from conventional investment options such as stocks and debt securities, AIFs provide an exclusive investment pathway for sophisticated private investors seeking to broaden their portfolio and venture into alternative investment prospects.

Alternative Investment Funds (AIFs) are subject to governance and regulation by the Securities & Exchange Board of India (SEBI). They do not fall under the classification of Mutual Fund regulations prescribed by SEBI. As per the SEBI (Alternative Investment Funds) Regulation of 2012, AIFs are specifically defined as privately owned and operated investment funds, originating from either domestic or foreign sources. These funds are structured as body corporates, companies, limited liability partnerships (LLPs), or trusts. AIFs have the flexibility to adopt any of the aforementioned forms for their establishment.

Alternative Investment Funds are categorized into three sub-categories:

A. CAT I AIF:

  • Venture capital funds (including Angel Funds)
  • SME Funds
  • Social Venture Funds
  • Infrastructure funds

B. CAT II AIF

  • Private Equity Fund
  • Debt Fund
  • Real Estate Funds

C. CAT III AIF

  • Long Funds
  • Long- Short Funds
  • Hedge Fund
  • Private Investment in Public Equity Fund (PIPE)

COMPARISION BETWEEN CAT-II & CAT-III

Sl No.

Particulars

CAT-II

CAT-III

1

Investment Limit

The investment limit for Category II Alternative Investment Funds (AIFs) is capped at a maximum of 25% of the investable funds in an Investee company, either through direct investments or via investments in other AIFs. However, there is an exception to this limit for accredited investors participating in large value funds under Category II. These accredited investors have the flexibility to invest up to 50% of the total investable funds in an Investee company, either directly or through units in other AIFs.

Category III Alternative Investment Funds (AIFs) have certain investment restrictions. They are allowed to invest a maximum of 10% of the investable funds in an Investee Company, either directly or through investments in units of other AIFs. However, for accredited investors participating in large value funds under Category III, the investment limit is extended to 20% of the total available investable funds in an Investee Company, either directly or through other AIFs.

 

When calculating the investment limit for investments in listed equity of an Investee Company, AIF Category III can consider either 10% of the investable funds or the net asset value of the scheme. Similarly, for large accredited investors, AIF Category III can calculate the investment limit as 20% of either the investable funds or the net asset value of the scheme, subject to the conditions specified by SEBI on a periodic basis.

2

Investment Condition
  1. AIF Category II engages in investments in Investee companies, units of AIF Category I, or other disclosed Category II investments mentioned in the placement memorandum. It has the flexibility to invest directly in unlisted companies or through the acquisition of units from other AIFs.

 

  1. AIF Category II is prohibited from borrowing funds directly or indirectly or utilizing leverage, except for temporary funding needs. Temporary funding is limited to a maximum of 30 days and is allowed for up to four occurrences per year, but the borrowed funds should not exceed 10% of the investable funds.

 

  1. AIF Category II is permitted to engage in hedging activities, subject to the guidelines specified by SEBI at different intervals.

 

  1. AIF Category II may participate in the buying or selling of default swaps based on the conditions specified by SEBI.

 

  1. AIF Category II has the authority to enter into agreements with merchant bankers to subscribe to unsubscribed portions of issues or to facilitate the receipt or delivery of securities involved in market-making activities.

 

  1. AIF Category II is exempt from Regulation 3 and 4 of insider trading regulations when investing in companies listed on the SME exchange or SM segment of an exchange. However, this exemption is subject to specific conditions. The fund must conduct due diligence on such companies, disclose any trading in securities resulting from due diligence within two trading days, and maintain a lock-in period of one year for the investments made.

 
  1. AIF Category III diversifies its investments across various securities, including both listed and unlisted investee companies. It also invests in derivatives, units of other AIFs, and complex or structured products.

 

  1. AIF Category III engages in transactions involving physical settlement of commodity derivatives, where it deals with goods received upon delivery.

 

  1. AIF Category III has the flexibility to buy or sell credit default swaps, adhering to the conditions specified by SEBI.

 

  1. AIF Category III has the option to employ leverage or borrowings, but only with the consent of the fund's investors and within the maximum limit set by SEBI. In such cases, the fund is obligated to disclose information about the overall level of leverage utilized, including the level of leverage arising from cash borrowings and other sources.

 

  1. These investments are subject to regulation through the issuance of directions by SEBI. The directions cover areas such as operational standards, conduct of business rules, prudential requirements, restrictions on redemption, and the management of conflicts of interest.

3

Valuation Condition

AIF Category II is required to undergo investment valuation conducted by an independent valuer appointed by the AIF. This valuation process is carried out once every 6 (six) months. However, it is possible to extend the valuation period to 1 (one) year with the approval of a minimum of 75% of the investors based on the value of their investments in the AIF.

AIF Category III is obligated to ensure that the calculation of the net asset value (NAV) remains independent of the fund management function. Furthermore, the AIF must disclose the NAV to the investors at intervals shorter than a quarter for close-ended funds and at intervals no longer than a month for open-ended funds.

4

Tenure

AIF Category II operates as a close-ended fund with a minimum tenure of 3 (three) years, which can be extended for an additional period of 2 (two) years. The extension is subject to approval from at least 2/3rd of the unit holders, based on the value of their investments in the AIF.

it's important to note that only the closed-ended funds can be register under Category III AIF and have the provision to be extended for a period of 3 (three) years.

5

Reporting Events

AIF Category II is required to provide an annual report to investors, containing all the information as specified under Regulation 22 of the SEBI (AIF) Regulations, 2012. This report must be submitted within 180 days from the end of the year

AIF Category III is responsible for delivering quarterly reports to investors within 60 days from the end of the respective quarter.

6

Continuing Interest

In AIF Category II, the manager or the Sponsor is required to maintain a continuing interest in the AIF, which should be more than 2.5% of the corpus or Rs. 5 crore, whichever is lower. This continuing interest must be in the form of an investment in the AIF and cannot be fulfilled by waiving management fees.

Within AIF Category III, the continuing interest of the manager or the Sponsor must exceed 5% of the corpus or Rs. 10 crores, whichever is lower.

7

Taxation aspect

In AIF Category II, the tax liability is to be borne by the investor.

In AIF Category III, the fund itself is responsible for bearing the tax liability.