Over the past couple of years, we have been witnessing a trend of portfolio managers quitting their high paying jobs to start boutique asset management companies. Most of such boutique firms have been launching Alternative Investment Funds (AIFs) as they offer more flexibility to the fund manager and have potential for higher alpha generation through niche strategies.
AIFs were categorised as a separate investment vehicle in December 2012 when SEBI came out with a separate set of regulations for AIFs. Before that, such funds were under the purview of VCF Regulations – 1996. Although it’s early days, the AIF industry is set to grow at a rapid pace if the data is anything to go by. There are currently 503 AIFs registered with SEBI as on November 18, 2018.
In this part one of article, we seek to provide our readers a brief introduction about the AIFs.
What are AIFs?
Alternative Investment Funds are privately pooled investment vehicles incorporated in the form of a trust/ company/ body corporate or a LLP. These funds are not regulated by any SEBI Regulations governing the fund management activities (Mutual Funds & Collective Investment Schemes) or by any other regulator like IRDA, RBI or PFRDA. Therefore, by the definition of AIF it covers Venture Capital funds, Infrastructure funds, Private Equity funds, Hedge funds, Debt Funds (Credit) etc.
An AIF can launch several schemes. AIFs are typically designed for sophisticated or savvy investors (Indian as well as foreign) whose risk appetite is considerably higher.
AIFs are categorised into three. All three categories have seen significant growth in terms of raising funds.
Let’s take a brief look at each category of AIF’s:
Category I AIF
These are the AIFs which invest in start-up or early stage ventures, social ventures, SMEs, infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable. They typically have positive impact on the economy, for which they are entitled to receive certain incentives or concessions by SEBI or Government of India. In this category, leverage is not permitted unless it is for meeting temporary funding requirements for not more than 30 days, on not more than four occasions in a year and not more than 10% of the corpus. Angel Funds, Venture Capital Funds, SME Funds, Social Venture Funds and Infrastructure Funds are included in this category. The schemes launched under this category will be close ended schemes
Category II AIF
In this category no specific incentives or concessions are given. Leverage is not permitted in category II AIF unless it is to meet day to day operational requirement. Private Equity, Funds for distressed assets, and Debt funds (Credit) are included in this category. The schemes launched under this category will be close ended schemes
Category III AIF
The funds that are not covered under category I & Category II are covered under category III. These funds run diverse and complex strategies to deliver higher returns. Leverage of up to 2X the corpus is allowed in this category, which may be done through investments in listed or unlisted derivatives. These funds may invest in Category I and II AIFs as well. They receive no specific incentives or concessions from the government or any other regulator. Hedge funds and PIPE (Private Investment in Public Enterprises) funds are included in this category. The schemes launched under this category can be close ended or open ended.
Other Regulations and Restrictions of AIFs:
- The minimum ticket size is Rs 1 crore.
- The manager or sponsor/ promoter of the AIF have to invest 2.5% of the initial corpus or Rs 5 Cr whichever is lower in category I & II funds.
- The manager or sponsor/ promoter of the AIF have to invest 5% of the initial corpus or Rs 10 cr whichever is lower in category III funds.
- No more than 1,000 investors can invest in one scheme.
- It is mandatory for each scheme to raise at least 20 crore.
- Category I and II AIFs are not permitted to invest more than 25% of the investible funds in one Investee Company while the limit is 10% for Category III AIFs. There are no sector limits.
- Post the final closing of the scheme, units of close ended schemes are allowed to be listed on stock exchanges. (Minimum tradable lot size of Rs 1 cr)
As the markets mature, owing to the strict regulations, mutual fund schemes may not enjoy similar levels of outperformance with benchmark indices. Increasing size of AIFs is indicating a beginning of new era of money management in the Indian markets.
We’ll discuss more insights about the AIF industry in India in the part II of the article.