Alternative Investment Funds (AIF): Meaning, Types, Benefits & How to Invest in India

As Indian investors move beyond traditional options like mutual funds, stocks, and fixed deposits, Alternative Investment Funds (AIFs) have emerged as a powerful investment avenue for wealth creation and diversification. Designed specifically for qualified and non-retail investors, AIFs provide access to opportunities such as private equity, startups, real estate, and hedge fund strategies, areas not available through regular investment products.

In this blog, we explain what is AIF, the types of alternative investment funds, their benefits, categories, a list of alternative investment funds in India, and how to invest in AIF.

What is AIF (Alternative Investment Funds)?

The AIF full form is Alternative Investment Fund. According to SEBI, an AIF is a privately pooled investment vehicle that collects funds from sophisticated investors and invests them as per a defined investment strategy.

In simple terms, an AIF fund invests in non-traditional asset classes such as:

• Private and unlisted companies (Growth stage)
• Startups and early-stage ventures (Seed stage)
• Real estate and infrastructure
• Distressed or special situation assets (Debt restructuring)
• Hedge fund and derivative-based strategies

Types of Alternative Investment Funds in India

SEBI classifies types of AIF into three broad categories based on investment strategy and risk profile.

Category I AIF – Economic & Social Growth Focus

These funds are encouraged by the government and SEBI because they provide capital to "underserved" or vital sectors of the economy.

• Funds include:

1. Venture Capital Funds (VCF): These pool money to invest in startups and small businesses that have high growth potential but are too early for a bank loan.
2. Angel Funds: A "super-early" version of VCFs. They provide the very first check to an entrepreneur, often when the business is just an idea or a prototype.
3. SME Funds: Specifically target "Small and Medium Enterprises" (SMEs). These funds help traditional businesses scale up their operations or enter new markets.
4. Social Impact Funds: They invest in companies that solve social or environmental problems (like affordable healthcare or clean energy) while still aiming to make a profit.
5. Infrastructure Funds: These invest in "hard" assets, such as highways, airports, and power plants. They are perfect for investors looking for steady, long-term growth tied to India’s physical development.

• New Addition: Special Situation Funds (SSF) - These are now a distinct sub-category under Category I, focusing on "stressed assets" or companies undergoing insolvency.
• Key Advantage: Often eligible for certain regulatory concessions.
• Risk Level: High (due to the early stage or long-gestation nature of projects).

Category II AIF – Private Equity & Private Credit

This is the "catch-all" category and is currently the most popular in India by total assets managed. These funds do not use leverage for investing.

• Funds include:

1. Private Equity (PE) Funds: These invest in established, unlisted companies that need capital to expand, restructure, or prepare for an IPO (going public).
2. Debt/Private Credit Funds: Instead of buying shares, these funds lend money to companies. They act like a private bank, earning high interest rates that are passed on to you.
3. Real Estate Funds: These pool capital to buy or develop commercial and residential properties. They allow you to be a "large-scale landlord" without the hassle of managing property yourself.
4. Fund of Funds (FoF): A "diversified" fund that doesn't invest in companies directly. Instead, it invests in other AIFs, spreading your risk across different managers and strategies.

• Strategy: Focuses on unlisted companies that are in their growth or mature phase.
• Note on Debt Funds: In 2025-26, "Private Credit" AIFs have surged in popularity as they provide higher yields than traditional fixed income.
• Risk Level: Moderate to High.

Category III AIF – Advanced Trading & Hedge Strategies

These are the only AIFs permitted to use leverage (borrowing to invest) and complex derivatives. They can be open-ended (allowing investors to enter/exit more frequently).

• Funds include:

1. Hedge Funds: These are the most flexible. They can buy stocks (long) or bet against them (short). Their goal is to make money whether the market is going up or down.
2. PIPE Funds (Private Investment in Public Equity): These funds buy a large "private" chunk of shares in a listed company, usually at a discount, to help that company raise capital quickly.
3. Quant/Arbitrage Funds: These use computer algorithms to find tiny price differences between different markets (like BSE vs. NSE) and profit from them instantly.
4. Long-Short Funds: A specific type of strategy where the manager buys "winners" and sells "losers" simultaneously to reduce the overall risk of the stock market crashing.

• Strategy: They can "short" the market (betting on prices falling) or use arbitrage to make money even in volatile markets.
• Risk Level: Very High (due to leverage and market sensitivity).

Understanding the “J-Curve” Effect in AIFs

In Category I and II AIFs, especially private equity and venture capital funds, returns often follow a J-Curve.

• Initial years may show low or negative returns
• This happens due to setup costs, management fees, and early investments
• Significant returns typically appear in later years, once portfolio companies mature or exit

This is normal and should not be confused with poor performance.

Important: AIFs Are NOT for Retail Investors

AIFs are "exclusive" products designed for high-net-worth individuals who can absorb higher risks. As of the 2025–2026 SEBI amendments, the rules have become even more specific:

• The "1,000 Investor" Rule: A standard AIF scheme is generally capped at 1,000 investors. However, Accredited Investors are now excluded from this count. This allows funds to scale significantly larger without breaching regulatory limits, effectively enabling "unlimited" scaling for funds that cater only to Accredited Investors.
• The "Accredited Investor" Mandate (2026 Update): To join an Angel Fund, you must now be an Accredited Investor. This requires a certificate from a SEBI-approved agency (like NSDL or CDSL) proving you meet wealth criteria [e.g., Annual Income of ₹2 Cr+ OR Net Worth of ₹7.5 Cr+ (with at least ₹3.75 Cr in financial assets)].
• No More "Per Scheme" Cap for Angel Funds: Angel Funds no longer launch separate legal "schemes" for every deal. Everything is consolidated at the fund level.
• Unlimited Scaling: By shifting to an Accredited-only model, the old cap of 200 investors per deal is being removed.
• Deadline: Existing funds have until September 8, 2026, to transition their investor base to the new Accredited standard.
• Minimum Investment Changes:
• Standard AIFs: The minimum ticket size remains ₹1 Crore.
• Angel Funds: The previous ₹25 Lakh minimum has been scrapped for Accredited Investors. There is now no regulatory minimum for individual investors, allowing for more flexible participation.
• Investee Limits: While the entry ticket for you is lower, the Angel Fund itself now has a wider range: it can invest between ₹10 Lakh and ₹25 Crore per startup (previously ₹25 Lakh to ₹10 Crore).

Taxation of Alternative Investment Funds

Category I & II AIF – Pass-Through Taxation

• The fund itself does not pay tax
• Income is taxed in the hands of the investor
• Tax treatment depends on the nature of income (capital gains, interest, etc.)

Category III AIF – No Pass-Through

• Tax is paid at the fund level
• Taxed at the highest marginal rate
• Investors receive post-tax returns

Taxation is one of the most important factors when choosing the type of AIF.

Benefits of Investing in Alternative Investment Funds (AIFs)

Investing in Alternative Investment Funds (AIFs) offers several advantages for qualified investors looking beyond traditional asset classes:

• Portfolio Diversification Beyond Traditional Assets: AIFs invest in alternative assets such as private equity, startups, real estate, and hedge strategies. This helps reduce dependence on equity and debt markets and improves overall portfolio diversification.
• Access to Exclusive Investment Opportunities: AIF funds allow investors to participate in unlisted companies, early-stage ventures, and special situations that are not accessible through mutual funds or public markets.
• Potential for Higher Risk-Adjusted Returns: With flexible investment mandates and specialised strategies, alternative investment funds have the potential to generate superior long-term returns, especially in private equity and venture capital segments.
• Professional and Specialised Fund Management: AIFs are managed by experienced investment professionals with deep expertise in niche areas such as private credit, distressed assets, or hedge strategies, enabling informed decision-making.
• Lower Correlation with Public Markets: Since many AIF investments are not directly linked to stock market movements, they can provide stability during market volatility and economic downturns.
• Alignment of Investor and Manager Interests: AIF sponsors and managers are required to invest their own capital in the fund, ensuring they have “skin in the game” and are aligned with investor outcomes.
• Customised and Flexible Investment Strategies: Unlike mutual funds, AIFs have the flexibility to design tailored strategies based on market conditions, allowing them to adapt quickly and capture niche opportunities.

List of Alternative Investment Funds in India

Below is an indicative list of alternative investment funds in India registered with SEBI:

Fund Name:

Always review the fund’s Private Placement Memorandum (PPM) before investing.

Fee Structure of AIFs

Unlike mutual funds, AIFs follow a performance-linked fee model.

Common structure:

• 2% management fee (annual)
• 20% performance fee (carried interest) on profits above a hurdle rate

This aligns the fund manager’s interest with investor returns.

How to Invest in AIF in India?

Here’s a clear, step-by-step guide on how to invest in AIF:

1. Check Your Eligibility: AIFs are "Private Placement" vehicles. You must qualify as:

• Resident Indian / NRI / Foreign National: All are eligible, subject to FEMA/RBI guidelines.
• Sophisticated Investor: You must demonstrate the ability to invest large tickets and understand that capital is not guaranteed.

2. Understand the Investment Thresholds:

• Standard AIFs (Cat I, II, III): The minimum investment remains ₹1 Crore.
• Angel Funds (The 2026 Shift): The previous ₹25 Lakh minimum has been removed for investors who hold an Accredited Investor Certificate. If you are accredited, you can now invest smaller amounts, allowing for better diversification across multiple startups.

3. Choose Your Strategy & Evaluate the Manager: Don't just look at past returns. In 2026, SEBI mandates standardised Performance Benchmarking.

• Ask for the Benchmark Report: Compare the fund's performance against its peers using SEBI-approved valuation data.
• Check the "Sponsor's Commitment": Ensure the manager has their own money (skin in the game) invested in the same units as you.

4. Deep Dive into the PPM (Private Placement Memorandum): The PPM is the single most important legal document for an AIF investor. Pay close attention to:

• The "Hurdle Rate": The minimum profit the fund must make before the manager takes a "performance fee."
• The "Investment Period" vs. "Tenure": A fund might have a 7-year tenure but only a 3-year window to find and make new investments.

5. Complete KYC & Accreditation:

• Standard KYC: PAN, Aadhaar, and Bank details.
• Accreditation (Optional but Recommended): To unlock lower minimums in Angel Funds or "Large Value Funds," you may need to obtain an Accreditation Certificate from agencies like NSDL/CDSL.

6. The Commitment & Drawdown Process: AIFs don't take all your money on Day 1.

• Commitment: You sign a legal agreement promising, for example, ₹1 Crore.
• Drawdown (Capital Call): The fund will send "Drawdown Notices" (usually with a 15–30 day window) whenever it finds a specific company to invest in.
• Pro-Rata Rights: As per 2025 rules, drawdowns must be strictly pro-rata across all investors to ensure fairness.

7. Monitoring & Tax Filing:

• Periodic Reporting: Expect quarterly (Cat III) or annual (Cat I & II) reports.
• Form 64B / 64C: Since Cat I & II are "pass-through," the fund will issue these forms annually. You will need them to report AIF income in your personal Income Tax Returns (ITR).

Risks Associated with AIF Investment

Below are the key risks associated with AIF investment:

• Illiquidity Risk: Most AIFs, especially Category I and II funds, are close-ended with long lock-in periods of 5–7 years. Investors cannot exit at will, making AIFs unsuitable for short-term liquidity needs.
• Capital Loss Risk: AIFs often invest in unlisted companies, startups, or stressed assets. These investments may underperform or fail, leading to partial or complete loss of capital.
• Market and Economic Risk: AIF returns are influenced by broader economic conditions, interest rate changes, and market cycles. A slowdown can delay exits or reduce valuations, impacting overall returns.
• Complexity and Transparency Risk: The investment strategies used by AIF funds, especially in Category III, can be complex and difficult for investors to track or fully understand, increasing the risk of misjudging performance.
• Valuation Risk: Since many AIF investments are in unlisted or illiquid assets, valuations are not market-driven and may be subjective, leading to potential discrepancies in reported returns.
• Manager and Execution Risk: AIF performance depends heavily on the fund manager’s expertise and execution capabilities. Poor investment decisions or weak governance can significantly impact outcomes.
• Regulatory and Taxation Risk: Changes in SEBI regulations or tax laws can affect fund structures, returns, and post-tax income for investors, particularly in Category III AIFs.

Conclusion

Alternative Investment Funds offer a compelling opportunity for investors seeking diversification, higher return potential, and access to exclusive assets. However, due to high minimum investment, long lock-in periods, complex strategies, and taxation nuances, AIF investment is best suited for informed and patient investors. Understanding the types of AIF, fee structure, taxation, and risks is essential before committing capital.

FAQs

1. What is AIF in simple terms?

An Alternative Investment Fund (AIF) is a privately pooled vehicle that collects capital from sophisticated investors (HNIs, institutions, and family offices). It invests in non-traditional assets like startups, private equity, real estate, or complex trading strategies that are usually out of reach for regular retail investors.

2. What is the minimum investment in AIF?

• Standard AIFs (Cat I, II, & III): The minimum investment is ₹1 Crore.
• Angel Funds: Under the "Angel Fund 2.0" rules, the ₹25 Lakh minimum is scrapped for Accredited Investors. However, the fund itself must now invest at least ₹10 Lakh in any startup (previously ₹25 Lakh).

3. Are AIFs better than mutual funds?

They are not "better," but they serve different purposes. Mutual funds are highly regulated, liquid, and retail-friendly. AIFs offer higher flexibility and potential for "Alpha" (market-beating returns) through private assets and leverage, but they come with higher risks, lower liquidity (long lock-ins), and a much higher entry cost.

4. How many types of AIF are there?

SEBI classifies them into three categories:

• Category I: Social impact, SMEs, infrastructure, and Angel Funds.
• Category II: Private equity, private credit, and real estate (no leverage).
• Category III: Hedge funds and complex trading strategies (can use leverage)

5. Are AIFs regulated in India?

Yes. All AIFs must be registered with and are strictly regulated by the Securities and Exchange Board of India (SEBI).