A Beginner's Guide To Investing In India's Ai Future

Alternative Investment Funds (AIFs) are a type of investment fund in India that offers a higher rate of return compared to conventional options like cash, bonds, and stocks. AIFs target sophisticated investors, such as high-net-worth individuals (HNIs) from India and abroad who have large amounts of capital to invest. These funds do not fall under the regulations of any regulatory authority in India but are classified under the SEBI (Alternative Investment Funds) Regulation of 2012. To start investing in AIFs, an investor must have a minimum corpus of Rs. 20 Cr for any particular scheme or Rs. 10 Cr in the case of an Angel Fund. The minimum investment for an individual is set at Rs. 1 Cr, providing exclusive and specialized investment opportunities for those with a high-risk appetite.

Minimum investment requirements for individuals

Alternative Investment Funds (AIFs) are established by foreign or domestic investors in India, and they pool money from high-net-worth individuals (HNIs). AIFs are mostly privately held and are not regulated by any Indian authority. However, they are classified under the SEBI (Alternative Investment Funds) Regulation, 2012.

To start investing in AIFs, an individual must fulfil the following criteria:

• The minimum investment for an individual is set at Rs. 1 Crore. However, for an employee, manager, or director of AIF, the minimum investment is Rs. 25 lakhs.
• Each investor has to submit ID proof, a PAN card, and proof of income.
• All Person of Indian Origin (PIO), Non-Resident Indians (NRIs), and Overseas Citizen of India (OCIs) can invest in AIFs as long as they follow the guidelines set by SEBI.

AIFs offer a diverse range of investment options beyond traditional choices, such as commodities, angel funds, real estate, and private equity. They are suitable for experienced investors with a high-risk tolerance and a large amount of capital to invest.

It is important to note that AIFs are riskier than traditional funds like cash, bonds, and stocks, and they require a higher minimum investment amount. Before investing, individuals should conduct thorough research on the fund's past performance and ensure they meet the eligibility criteria.

Categories of AIFs

Alternative Investment Funds (AIFs) are privately pooled investment vehicles that collect funds from sophisticated individual or institutional investors to invest in a variety of non-traditional assets. AIFs are regulated by the Securities and Exchange Board of India (SEBI) and are required to obtain registration to operate. They can be established as corporations, Limited Liability Partnerships (LLPs), trusts, or other forms.

There are three main categories of AIFs in India, each with distinct investment strategies and types of assets under management:

Category I AIFs

Category I AIFs focus on investments that benefit India's economic growth. These funds are considered important for employment generation and include:

• Venture Capital Funds (VCFs): VCFs invest in unlisted securities of start-ups, emerging or early-stage ventures with high growth potential. They are typically aimed at high-net-worth individuals with a high-risk, high-return policy.
• Infrastructure Funds: These funds primarily invest in companies engaged in infrastructure development, such as railroads, airports, and ports.
• Social Venture Funds: These funds invest in businesses that engage in philanthropic activities while also providing returns to investors.
• Special Situations Funds: These funds are a sub-category of Category I AIFs and focus on distressed debt. They can acquire debt/equity by participating in debt resolutions and financing companies facing financial difficulties.
• Corporate Debt Market Development Funds: These are close-ended AIFs formed as trusts with a 15-year tenure. They invest in corporate debt securities from debt-oriented mutual fund schemes during periods of market dislocation.

Category II AIFs

Category II AIFs include funds that do not fall into Categories I and III. They do not undertake leverage or borrowing beyond what is necessary for day-to-day operations. This category includes:

• Private Equity Funds: These funds invest primarily in equity or equity-linked instruments of unlisted private businesses that face challenges in raising capital.
• Debt Funds: Debt funds invest in debt securities of listed or unlisted companies, often including private debt that is considered alternative due to its illiquidity.
• Pre-IPO Funds: These funds invest in late-stage businesses before they go public.

Category III AIFs

Category III AIFs employ diverse and complex trading strategies and may use leverage through investment in listed or unlisted derivatives. They include:

• Hedge Funds: Hedge funds collect money from investors and corporations to invest in debt and equity markets, both domestically and internationally. They follow an aggressive investment strategy and have a high expense ratio.
• Private Investment in Public Equity (PIPE) Funds: PIPE funds invest in public firms by buying their shares at discounted prices.
• Long Only AIFs: These funds focus on long-term investments in various asset classes, aiming to profit from upward price movements.
• Long Short AIFs: Long Short AIFs employ a flexible strategy, taking both long and short positions in various asset classes. They can profit in both bullish and bearish markets by hedging and capitalising on specific investment opportunities.

Taxation on AIF investments

Category I and II AIFs

Category I and II AIFs have a pass-through status, meaning the income or loss (excluding business income) generated by the fund is taxed at the investor's level and not by the fund itself. Capital gains tax is levied on profits or losses made from the fund within a given duration. The applicable rate depends on whether the gains are long-term or short-term. As per the latest rules, long-term capital gains are taxed at 20% with indexation benefits, while short-term capital gains are taxed at 15%. Surcharge and cess charges are levied in addition to these rates. A withholding tax of 10% is also applicable, which helps investors reduce their overall tax liability.

Category III AIFs

Category III AIFs are taxed at the fund level, unlike the other categories. The highest rate of tax, as per the current tax slab, is charged on the profits made by these funds. This category of AIFs pays tax on four types of income: short-term capital gains, long-term capital gains, business income, and income other than capital gains.

How AIFs differ from mutual funds

AIFs (Alternative Investment Funds) are a unique investment vehicle that goes beyond traditional investments like fixed deposits, equity, mutual funds, stocks, etc. They are established by foreign or domestic investors in India to invest in several asset development tools such as real estate, hedge funds, private equity funds, debt securities, and more. AIFs pool money from high-net-worth individuals and are mostly privately held.

On the other hand, mutual funds are collective investment schemes managed by fund managers, offering diversified portfolios to retail investors. They help investors buy equity, debt, or a mix of both for a diversified portfolio containing stocks and bonds.

Investment Objectives

AIFs are designed for sophisticated investors looking for exposure to alternative assets like real estate, private equity, or hedge funds. They offer a higher degree of flexibility than mutual funds as they invest in unlisted shares and also use shorting and leverage. AIFs are not regulated by the Securities and Exchange Board of India (SEBI) under the conventional mutual funds or collective investment schemes.

Mutual funds, on the other hand, aim at long-term growth and are suitable for investors seeking professional management and liquidity through daily transactions. They are typically easier to access and offer flexible investment options, allowing investors to start with a small amount via SIP or a large corpus via lumpsum.

Investment Strategies

AIFs facilitate investment in non-traditional assets like real estate, startups, and private equity for potentially higher returns. They are not meant for the general public or retail investors due to their high risks, high costs, and low liquidity.

Mutual funds, in contrast, invest in stocks, bonds, or other securities managed by professional fund managers for retail investors. They invest in a combination of assets like shares, bonds, stocks, and short-term debt to ensure diversification, forming the basis of a well-balanced portfolio.

Minimum Investment Amount

AIFs typically require a substantial minimum investment amount, often starting at Rs. 1 crore. They are designed for high-net-worth individuals with a higher risk appetite and a desire for exposure to alternative asset classes.

Mutual funds, however, offer more flexibility in terms of investment amounts. With mutual funds, investors can start a SIP for as low as Rs. 100 and also opt for lumpsum investments.

Liquidity

AIFs have limited liquidity options due to strict lock-in periods. They are bound by these periods and have very few options to liquidate.

Mutual funds, on the other hand, provide high liquidity through daily NAV-based transactions, making them the most liquid among the two options.

Fees and Expenses

AIFs generally carry higher fees compared to mutual funds due to their focus on alternative asset classes and personalised service. They charge management fees of 2% and take 20% of the profits.

Mutual funds charge an expense ratio, typically ranging from 1% to 2.25%, as regulated by SEBI.

Risk Profile

AIFs carry higher risks due to their focus on alternative asset classes, which may lead to increased volatility and potential loss of capital for investors.

Mutual funds, while still involving risk, are generally considered a more straightforward and diversified investing strategy.

In summary, AIFs and mutual funds cater to different types of investors. AIFs are suitable for sophisticated investors with a higher risk appetite, while mutual funds are more accessible and suitable for those seeking a more diversified and liquid investment option.

How to start an AIF

To start an Alternative Investment Fund (AIF) in India, you must register with the Securities and Exchange Board of India (SEBI). Here is a step-by-step guide on how to start an AIF:

Choose the Right Legal Structure:

Select the appropriate legal structure for your AIF from the following options:

• Trust: Registered under the Trust Act of 1882.
• Company: Registered under the Companies Act, 1956 or 2013.
• Limited Liability Partnership (LLP): Registered under the LLP Act, 2008.

Each structure has different legal and regulatory requirements, so choose the one that best suits your investment strategy and needs.

Determine the AIF Category:

SEBI categorizes AIFs into three types based on their investment focus and strategies:

• Category I AIF: Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or sectors deemed socially or economically desirable.
• Category II AIF: Includes funds that do not fall into Category I or III, such as private equity or debt funds.
• Category III AIF: Employs complex trading strategies, leverages investments, and trades for short-term returns.

Check Eligibility Criteria:

Ensure that you meet the eligibility criteria set by SEBI for AIF registration:

• Allowed Business Activities: Your Memorandum of Association (MoA) or Trust Deed/Partnership Deed must permit AIF investment activities as per the applicable category.
• Private Subscription: Your founding documents should prohibit public invitations to subscribe to securities.
• Legal Incorporation: Trusts, LLPs, and companies must be registered under the respective laws.
• Fit and Proper Criteria: Applicants, sponsors, and managers must meet the "fit and proper" criteria specified by SEBI.
• Qualified Management: Your AIF management team must have relevant experience and professional qualifications, such as CFA or CA.
• Infrastructure and Manpower: Ensure you have the necessary infrastructure and manpower to manage AIF activities effectively.
• Clear Investment Plan: Clearly outline your investment objectives, targeted investors, proposed corpus, investment strategy, and proposed tenure.

Submit Application to SEBI:

Fill out and submit Form A of SEBI (Alternative Investment Funds) AIF Regulations 2012, along with the required details and documents:

• Key Personnel and Experience: Provide details on the qualifications and experience of your key personnel.
• Private Placement Memorandum (PPM): Include a draft PPM, which outlines your fund's investment strategy and terms.
• Application Fee: Pay the non-refundable application fee of Rs. 1,00,000.

SEBI Review and Verification:

SEBI will review your application, verify documents, and may request additional information or clarifications. They may also conduct a personal meeting or inspect your office to ensure you meet the requirements.

Receive Registration Certificate:

If your application is approved, SEBI will inform you and grant the Certificate of Registration of Alternative Investment Fund. A registration fee of Rs. 5 lakh is applicable if you are not already registered with SEBI as a Venture Capital Fund.

Comply with Post-Registration Requirements:

As an AIF, you must comply with ongoing regulatory requirements, such as reporting guidelines, investment limits, and conflict of interest disclosures. Ensure that you understand and adhere to these requirements to maintain your AIF registration in good standing.

Frequently asked questions