Rise of Alternative Investment Funds in India

The name Alternative Investment suggests investments which aren’t traditional by nature and it differs not only in types of asset classes but also the structure of the investment vehicle. On comparing Alternative Investments with Traditional Investments, we can notice that –

  • Alternative Investments have less liquidity of assets.
  • It requires specialized investment managers.
  • They are more concerning since there is no historical data on return and volatility data.
  • They have different legal issues and tax treatments.

But in spite of the above stated issues, Alternative Investments Funds (AIF), a part of Alternative Investments is on the rise in India. Alternative Investment Funds refers to privately pooled investment funds, either from Indian or foreign sources. AIFs were allowed by SEBI in 2012, and by end of 2013, there were 84 registered AIFs in India.

When we look at the year 2013, India was ranked 9th by the Global Limited Partner Survey of ‘Emerging Markets Private Equity Association’ for the ‘most preferred destination’ by global investors. Fast forward to 2017, India has been ranked numero uno in the same category. This upward climb on the ladder can be attributed to the rise of AIFs in India from 84 registered AIFs in 2013 to 517 in 2019, more than a six-fold increase.

Relation between AIFs and Indian Economy

According to SEBI, AIFs are classified in 3 broad categories –

  • Category I– These AIFs invest in startups, early stage ventures, infrastructure, SMEs or any area which the government and regulators think are socially and economically beneficial. Category 1 AIFs include Venture Capital Funds, SME funds, Infrastructure funds etc.
  • Category II- The AIFs which don’t fall in category 1 and 3 are the part of this category. These mainly include Private Equity funds, Real Estate funds et al. These funds don’t take leverage or borrowing for their operational requirements.
  • Category III- The AIFs which use complex trading strategies and employ debt including through listed or unlisted derivatives fall under this category. Hedge funds, PIPE funds et al are to name a few.

AIFs offer High Net worth Investors (HNIs) and Institutional Investors diversified portfolios which are not offered by the traditional investment options. Over the period of last 7 years the funds raised and invested by AIFs have been increasing year on year. This in turn shows the growth of the Indian economy landscape. India being a developing country the scope of investment in vast and the government is trying to make India not only business friendly but also investor friendly which further increases the scope for AIFs. AIFs invest in startups, SMEs, infrastructure, real estate etc. using mutual funds strategies and by not taking long or a short position which helps in direct capital infusion.

Over the years the Indian government has taken various steps in favor of AIFs such as –

  • RBI issued a notification in 2015 wherein it stated that AIFs having majority foreign capital will be considered as local fund and FDI regulations won’t be applicable. This was under Automatic Route.
  • Category III funds are allowed to invest in commodity derivatives.
  • Proper structure was put in place to avoid double taxation for the Category I and II funds investors.
  • Government of India has set up National Infrastructure Fund of INR 20,000 crores.
  • AIFs being illiquid by nature, but allowing them to be listed on stock exchange help them to be traded easily. All AIFs expect the open-ended AIF can be listed on the stock exchange.
  • Funds of Funds are the funds which invest in multiple Category III funds. Although in India it’s still at a nascent stage.

From the above graph we can see the gradual but a steady rise not only in the funds raised but also in the investments made by AIFs. India being a young nation with a lot of untapped capital and has tremendous growth prospects in the future and with such funds on a rise will not only help to reduce the investment deficit of the country but also harness her growth potential.

AIFs being diverse are able to meet the financial needs to HNIs wherein they can choose between short term i.e. liquid funds and long term i.e. physical assets or longer duration funds.  AIFs has low returns correlation with the traditional investment products in longer period and aren’t as volatile as stock and bond markets which helps to reduce the portfolio risk.

Although AIFs market is rapidly growing in India it is still paltry in comparison to the global AIF market. The regulators and Government have taken various steps in favor of AIFs there is still a long way to go from here. But the future does look bright.

Isha Khuteta
Team Member– Alternative Investment Funds
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Isha on LinkedIn