Alternative Investment: What You Need to Know About It

Alternative Investment Funds are vehicles that invest in a non-traditional asset. Here vehicle means any trust, corporate company, or Private Limited Partnership. 

A few examples of non-traditional assets are Real Estate, Infra, Venture Capital, etc.

Key Takeaways

• An alternative investment funds are also a type of asset, but it does not come under the traditional investment categories, including shares and bonds, etc.
• Conventional categories include stocks, bonds, and cash. 
• Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, lack of regulation, and degree of risk.
• Funds like hedge funds, venture capital, and private equity come under alternative investments. 

What is the Alternative Investment Fund in India?

An alternative Investment Fund is a privately pooled vehicle similar to a mutual fund that invests in venture capital, private equity, hedge funds, managed futures, etc. An AIF refers to an investment that differs from conventional investment avenues such as stocks, debt, securities, etc.

But investment funds (from Indian or foreign sources), in the form of a trust, company, or body corporate. Alternative investment fund is not regulated by regulation 2(1)b of SEBI Regulations 2012. AIF can be established in the form of a company or a corporate body or a trust, or a Limited Liability Partnership (LLP).

Generally, high net worth individuals and institutions invest in AIFs as it requires a high investment amount, unlike Mutual Funds.

So, AIFs are private funds that otherwise do not come under the jurisdiction of any regulatory agency in India.

Features of Alternative Investment Funds

1. Private pooling – Fewer Regulations
2. Illiquid-lock-in
3. High risk – more time
4. Indian / foreigner investors 

How to Get Registered as an Alternative Investment Fund SEBI

Step 1 – The applicant for grant of registration as an Alternative Investment Fund under SEBI Regulations, 2012, should make an application to SEBI inform A as provided in the Regulations and all the necessary documents. 

Step 2 – Generally, on receipt of the application, the applicant will receive a reply from SEBI within 21 working days. However, the time taken for registration depends on how fast the applicant complies with the requirements.

Step 3 – The applicant is advised to go through the SEBI Regulations, 2012, to check the eligibility criteria and other details which may help expedite the registration process.

 Step 4 – The applicant must mention in the covering letter whether:

1. It is registered with SEBI as a Venture Capital fund. If yes, provide details. 
2. It has been undertaking the activities of an AIF before such application. If yes, provide details.
3. It is applying for the registration of a new fund. 

Step 5 – The applicant will have to submit the following documents as it is necessary for the registration process.

1. Please fill out the form properly and make sure it is signed and stamped. 
2. By bank draft in Mumbai, SEBI pays Application fees of Rs. 1,00,000.

Step 6 – The applicant shall also make an online applicant according to the guidelines as prescribed by SEBI from time to time. 

There are three categories of Alternative Investment Fund, which are given below:

Category-I AIF

Alternative investment funds invest in startups, early-stage ventures, or any other sectors that the government or the regulator considers socially and economically viable. E.g. Angel Fund, Venture Capital Fund, SME Funds, Social Venture Funds, Infrastructure funds, etc.

Category-II AIF

Alternative Investment Funds that don’t fall in Category-I and Category-III and don’t undertake to borrow other than meet day-to-day operational requirements. The government or any other regulator gives no incentive or concessions.

Various funds such as real estate funds, private equity funds, funds for distressed assets, etc., come under this category.

Category-III AIF

Alternative Investment Funds such as hedge funds or funds that are traded to make short-term returns or other open-ended funds and for which the govt or any other regulator gives no specific incentives or concessions. E.g. Hedge Fund, PIPE Funds.

Alternatives Investment Funds provide benefits of diversification, risk mitigation, and enhanced returns.

Benefits of Investing in Alternative Investment Funds

When people invest in a fund, they evaluate the benefits of an Alternative Investment Fund. 

There are several benefits of AIFs given below – 

• Know about the Tax Benefits 
• Identify the Passive Investments
• Look at the direct ownership.
• Uncorrelated with the stock market

Types of Alternative Investment

1. Hedge Fund – A hedge fund uses funds collected from accredited investors like banks, insurance firms, High Net-Worth Individuals (HNIs) and families, and endowments and pension funds. Hedge fund managers trade globally in currencies, equities, commodities, and bonds. SEBI registration is not necessary for the hedge fund. It is also unnecessary to disclose their NAV periodically like other mutual funds. Investments should be extremely high and make high-risk investments. 

2. Private Equity (PE) Fund – The fund that invests in the equity of private companies intending to exit at higher valuations in the future. They take public companies private and use Leveraged Buy-Out (LBO) strategy. Higher leverage, higher risk, and higher expected return in this investment.

3. Venture Capital – Venture capital funds are the subset of private equity funds. These are professionally managed funds invested in young companies with potential. Venture capitalists provide expertise and mentorship and act as a litmus test of where a business organisation is going, evaluating business from a sustainability point of view. 

Venture capital funds invest in these early-stage companies in exchange for equity, or an ownership stake, in the companies they invest in. Business startups face high uncertainty, and Venture Capital investments have high failure rates.

1. Real Estate is the equity and debt investment in residential and commercial property. Investment can be made by Real Estate Investment Trusts (REITs). REITs are private investment vehicles that own properties or associated loans.

2. Infrastructure Fund means investing in infrastructures like water pipelines, toll roads, ports and airports and growing business through private equity.

Words to remember

Seed Capital: Converting a new idea into a product or service-high risk involves VCFs providing funds for meeting the pre-startup stage requirement.

Start-up Capital: Product is commercialised capital for product development and initial marketing, the riskiest financing stage.

Angel Funds:  To strengthen the startup company by providing access to early-stage financing, a high-quality mentor network, and access to global markets is the intention of Angel Fund. An Angel fund is a fund invested by angel investors who are individuals with surplus cash who have been interested in investing in upcoming startups. 

They also offer mentoring or advice alongside capital. Minimum of 1000 sophisticated Investors except for Angel Fund. Minimum 49 investors of minimum Rs. 25 lakhs in case of angel fund alternative investment fund.

Fund of Funds: As the name suggests, this fund is a combination of various Alternative Investment Funds. It means that you have to invest in a portfolio of other AIF. However, it should be kept in mind that funds under AIFs cannot issue units of fund publicity, unlike Fund of Funds under Mutual Funds.

Debt Fund: This fund primarily invests in debt instruments of listed and unlisted companies. As per the SEBI Regulations, the amount invested in a Debt Fund can’t be utilised to give loans; an AIF is a privately pooled investment vehicle.

Did you know?

Target Rate – The target rate is the rate of return aimed to be achieved.

Hurdle Rate – The hurdle rate is the rate of return achieved before incentives are given.

High Watermark – Once the hurdle rate is achieved, the rate is reset, and the benchmark is set.

With Catch-up – Performance fees only after the hurdle rate is achieved. 

Without Catch-up – Performance fees on the whole scheme.

Conclusion

Every investment has its profit and loss. Many times, alternative investment funds can be treated as passive investments. In an Alternative Investment Fund, a large initial investment is required, and it is out of reach for small-scale investors.

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