Understanding Alternative Investment: Category 2 Aifs Explained

Category 2 Alternative Investment Funds (AIFs) are those that invest in equity securities and debt securities. They are allowed to invest anywhere in any combination but cannot take on debt, except for day-to-day operational purposes. These funds are typically established as privately pooled investment vehicles in India to collect funds from specific investors according to a predefined investment policy. Examples of Category 2 AIFs include private equity funds.

Characteristics of Category 2 Alternative Investment Funds

Private equity funds

The relationship between the private equity firm and the company receiving the capital is an important aspect of private equity. In addition to capital, private equity firms often provide industry expertise, talent sourcing assistance, and mentorship to the companies they invest in.

Debt funds

As per the Securities and Exchange Board of India (SEBI) guidelines, the amount invested in a debt fund cannot be used to give loans. This is because AIFs are privately pooled investment vehicles.

AIFs are regulated by SEBI and can be established as a trust, company, limited liability partnership (LLP), or corporate body. They adhere to the SEBI (Alternative Investment Funds) Regulations, 2012.

Category 2 AIFs are those that do not fall under Category 1 or 3. They do not use leverage or debts other than to cover their day-to-day operational expenses. There are no specific incentives or concessions given by the government on investments in these funds.

Other funds that fall under Category 2 include Private Equity Funds, Fund of Funds, and Private Investment in Public Equity Fund (PIPE).

No government concessions

Category 2 Alternative Investment Funds (AIFs) are those that invest in equity securities and debt securities. This category also includes any funds that are not classified under Category 1 and 3. AIFs are privately pooled investment vehicles that collect funds from specific investors according to a predefined investment policy.

Category 2 AIFs are not incentivised or conceded by the government. This means that investors in these funds do not benefit from any tax breaks or other financial incentives that may be available for investments in other categories of AIFs.

The funds in this category are typically private equity funds, which invest in unlisted private companies and take a share of their ownership. These companies offer investors a diversified portfolio of equities, reducing the risk to the investor. Private equity funds usually have a fixed investment horizon of between 4 and 7 years, after which they aim to exit the investment with profits.

Another type of fund in this category is a debt fund, which primarily invests in debt instruments of listed and unlisted companies. These companies often have low credit scores and high-yield debt securities, presenting a high-risk, high-return opportunity for investors.

The minimum investment amount required for AIFs in India is Rs. 1 crore, except for angel funds, which require Rs. 25 lakhs. The minimum corpus of the funds is Rs. 200,000,000, and no more than 1,000 investors are allowed at any time.

AIFs are usually marketed towards high net-worth individuals and institutions as they require a high investment amount. These funds are an alternative to traditional investments such as stocks, debt securities, and mutual funds, and they can provide benefits such as reduced volatility and improved performance. However, due diligence is necessary before investing in these complex funds.

Examples of funds

Category 2 Alternative Investment Funds are those that invest in various equity and debt securities. This category includes all funds that are not covered under Category 1 and 3 by the Securities and Exchange Board of India (SEBI). No incentives or concessions are given by the government for investments in these funds.

Private Equity Funds

Private equity funds invest in unlisted private companies and take a share of their ownership. These companies cannot raise funds by issuing equity or debt instruments, so they turn to private equity funds. Private equity funds usually have a fixed investment horizon ranging from 4 to 7 years, after which the firm expects to exit the investment with profits.

Debt Funds

Debt funds primarily invest in the debt securities of listed and unlisted companies. These companies typically have low credit scores, high growth potential, and good corporate practices but face a capital crunch. As per SEBI guidelines, the money accumulated by debt funds cannot be used to give loans.

Fund of Funds

These funds invest in a portfolio of other Alternative Investment Funds (AIFs) rather than making their own portfolio decisions. Fund of Funds under AIFs cannot issue units of the fund publicly, unlike those under Mutual Funds.

Private Investment in Public Equity Fund (PIPE)

PIPEs invest in shares of publicly traded companies, acquiring them at a discounted price. This type of investment is more convenient than going for a secondary issue due to less paperwork and administration.

Hedge Funds

Hedge funds pool money from accredited investors and institutions, investing in both domestic and international debt and equity markets. They employ an aggressive investment strategy and can be expensive, as fund managers may charge an asset management fee of 2% or more, as well as taking 20% of the returns generated as their fees.

Compared to other categories

Category II Alternative Investment Funds (AIFs) are those that invest in a variety of equity and debt securities. This includes private equity funds and debt funds. These funds are allowed to invest anywhere and in any combination but cannot take on debt except for day-to-day operational purposes.

Category II AIFs are distinct from Category I and Category III AIFs. Category I AIFs invest in startups, small and medium-sized enterprises (SMEs), and new businesses with high growth potential. They are considered socially and economically viable and are incentivised by the government. Examples of funds in Category I include infrastructure funds, venture capital funds, and social venture funds.

On the other hand, Category III AIFs focus on short-term investments and employ complex and diverse trading strategies to achieve their goals. Examples of funds in this category include hedge funds and private investment in public equity funds.

It is important to note that Category II AIFs do not receive any incentives or concessions from the government for investments, unlike Category I AIFs. The minimum investment amount for an individual in a Category II AIF is ₹10,000,000, and the minimum corpus of the funds is ₹200,000,000.

Frequently asked questions