Introduction
Alternative Investment Fund as defined by SEBI (Alternative Investment Funds) Regulations, 2012 (“Regulation”) is “any fund established or incorporated in India which is a privately pooled vehicle which collects funds from investors, whether Indian or foreign, for investing it under a defined investment policy for the benefit of its investors”. It can be formed as a company, trust, or LLP [Regulation 2(1)(b)].
Registration of Alternative Investment Fund
The entity must apply to SEBI for AIF registration using the prescribed ‘Form A.’ SEBI assesses the entity’s eligibility by verifying its authorization to operate as an AIF according to its incorporation documents, duly filed and registered. Additionally, SEBI evaluates the fitness and propriety of the applicant, sponsor, and manager based on criteria in Schedule II of SEBI (Intermediaries) Regulations, 2008. The application must include a copy of the draft private placement memorandum and draft formats of the investment management and contribution agreements. [Chapter II of Regulations]
Manager and Sponsor
“manager” means any person or entity who is appointed by the Alternative Investment Fund to manage its investments by whatever name called and may also be same as the sponsor of the Fund. [Definitions 2(q)]
Threshold of Invesment by Manager/Sponsor
The Manager or Sponsor must maintain a stake in the Alternative Investment Fund (Category I and II), with a minimum of 2.5% of the corpus or five crore rupees, whichever is lower. This investment should not be obtained through waiving management fees. For Category III Alternative Investment Fund, the required stake is raised to a minimum of 5% of the corpus or ten crore rupees, whichever is lower.
Types of Alternative Investment Funds
| Category- I | Category- II [Regulation 3(4)(b)] | Category- III [Regulation 3(4)(c)] |
| Angel Funds | Real Estate | Hedge Funds |
| Venture Capital Funds | Funds of Funds | Private Investment in Public Equity Funds |
| Infrastructure Funds | Debt Fund | |
| Social Venture Funds | Private Equity Funds |
For the purpose of this primer, we will focus on Category II and Category III funds.
| Category- II | Category- III |
| Real Estate pool capital from many investors to invest in a diversified portfolio of real estate assets | Hedge Funds are private investment funds that use complex and risky strategies. The aim is to generate returns in a short time. |
| Funds of Funds Invests in other AIFs. They hold an investment portfolio of other AIFs. They do not directly invest in stocks, bonds, or other securities. | Private Investment in Public Equity Funds Invests in publicly traded firms by acquiring shares at a discounted price through private placements. |
| Debt Fund Invests in debt securities of listed or unlisted companies as per the fund’s stated objectives. Investment in debt funds is limited to HNIs and offers limited diversification. | |
| Private Equity Funds pool capital from investors to invest in privately held companies. |
Conditions to make investment in category II and category III
| Category II | Category III |
| Category II AIF is not permitted to invest more than 25% (twenty-five percent) of its investable funds in a single investee company. Provided that large value funds for accredited investors of Category II AIFs may invest up to 50% (fifty percent) of its investable funds in an investee company. A Category II AIF shall invest primarily in unlisted investee companies or in the units of category I or other category II AIFs. [Regulation 15 (1)(c)] | Category III AIF is not permitted to invest more than 10% (ten percent) of the investable funds in an investee company, directly or through investment in units of other AIFs and the large value funds for accredited investors of Category III AIFs may invest up to 20% (twenty per cent) of the investable funds in an investee company, directly or through investment in units of other AIFs. [Regulation 15 (1)(d)] |
| AIF Category II is prohibited from borrowing funds directly or indirectly, and is restricted to using leverage solely for addressing short-term funding needs, limited to a maximum of four instances per year, lasting no more than 30 days each. Additionally, leverage can only be applied to an extent greater than 10% of the investable funds. [Regulation 17 (1)(c)] | AIF Category III invests in securities of listed as well as unlisted investee companies, derivatives, units of other AIFs, and complex or structured products. [Regulation 18 (a)] |
| AIF Category II is permitted to participate in hedging activities, but it must adhere to the guidelines set forth by SEBI, as updated periodically. [Regulation 17 (1)(d)] | It deals in goods received in delivery against physical settlement of commodity derivatives. |
| AIF Category II may also buy or sell default swaps in terms of conditions as may be specified by SEBI | It may buy or sell credit default swaps in terms of the conditions specified by SEBI. |
| AIF Category II may enter into an agreement with the merchant banker to subscribe to an unsubscribed portion of the issue or to receive or deliver securities that are in the process of market-making . [Regulation 17 (1)(e)] | It may also engage in leverage or borrowing but is subject to consent from the investors in the fund up to the maximum limit specified by SEBI. However, if it engages in leverage and borrowings then it has been to mandate to disclose information regarding the overall level of leverage employed, the level of leverage arising from borrowings of cash, etc. [Regulation 18 (c)] |
| AIF Category II are exempt from sub regulation 1 and 2 of Regulation 3 & subregulation 1 of Regulation 4 of insider trading regulations for investing in companies listed on the SME exchange or SM segment of an exchange pursuant to the due diligence of such companies and subject to the conditions that the fund shall disclose any trading in securities pursuant to due diligence within 2(two) trading days and the investment shall be locked in for a period of 1 (one) year from the date of investment. [Regulation 17 (1)(f)] | These investments are regulated by issuing directions regarding areas like operational standards, conduct of business rules, prudential requirements, restrictions or redemption and conflict of interest as prescribed by SEBI. |
Valuation of AIF
| Category II | Category III |
| Valuation of their investments needs to be done, atleast one in six months, by an independent valuer. [Regulation 23(2)] | calculation of Net asset value (NAV) is independent from the fund management function of AIF and shall be disclosed to investor not longer than a Quarter for close ended funds and at no longer than a month for open ended funds. [Regulation 23(3)] |
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