Alternative Investment Funds

A Beginner’s Guide to Alternative Investment Funds and Their Three Categories

What are Alternative Investment Funds?

Alternative Investment Funds (AIFs) are privately pooled investment vehicles that collect funds from sophisticated investors, both Indian and foreign and invest in accordance with a defined investment policy for the benefit of their investors. The Securities and Exchange Board of India (SEBI) regulates the AIFs, which are categorized into three categories based on their investment strategies and levels of risk. In this article, we will discuss the three categories of AIFs in detail.

Category 1 AIFs

Invest in start-up or early-stage ventures, social ventures, SMEs, infrastructure, or other sectors or areas that the government or regulators consider socially or economically desirable. They are typically long-term investors, and the funds raised are used to provide capital to such ventures. These funds also provide business and operational support to help these ventures grow. Venture capital funds, SME funds, social venture funds, and infrastructure funds fall under the Category 1 AIFs.

    • Venture Capital Funds invest in start-ups with high growth potential, while SME funds provide capital to small and medium-sized enterprises. Social venture funds invest in ventures with a social impact, while infrastructure funds invest in infrastructure projects.
    • Angel Funds, which are a subcategory of venture capital funds, invest in start-ups that are in the pre-revenue stage. Angel Funds provide seed funding to start-ups, and they are often the first investors in a company. Angel Funds are considered to be a critical source of funding for start-ups.
    • Social Venture Funds are funds that invest in socially responsible companies that seek to make a positive impact on society while also generating financial returns.
    • Infrastructure Funds are funds that invest in infrastructure projects such as highways, airports, power plants, and other public works projects. These funds typically invest in projects that generate stable cash flows over a long period of time and provide an essential service to the community.

Category 2 AIFs

They are those AIFs that do not fall under Category 1 or Category 3 and do not undertake leverage or borrowing, other than to meet day-to-day operational requirements, and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012. Various types of funds such as real estate funds, private equity funds (PE funds), funds for distressed assets, etc. are registered as Category 2 AIFs.

    • Real Estate Funds invest in real estate projects, including residential, commercial, and industrial properties. These funds may invest in properties directly or indirectly through Special Purpose Vehicles (SPVs).
    • Private Equity Funds invest in companies that are not listed on the stock exchange. They typically buy a substantial stake in the company and work closely with the management team to improve the company’s performance. PE funds are often long-term investors, and they exit their investment through an Initial Public Offering (IPO) or a sale to another company.
    • Funds for Distressed Assets invest in assets that are undervalued or are facing financial difficulties. These funds aim to acquire such assets at a low price and sell them when their value increases.

Category 3 AIFs

They employ diverse or complex trading strategies and may employ leverage, including through investment in listed or unlisted derivatives. These AIFs are the riskiest of the three categories and may invest in a wide range of assets, including stocks, bonds, currencies, and commodities.

Hedge funds, PIPE (Private Investment in Public Equity) funds, and other funds that employ complex trading strategies fall under the Category 3 AIFs.

    • Hedge Funds are known for their ability to generate high returns but also have a high level of risk. PIPE funds invest in publicly traded companies, typically buying a large stake in the company at a discount to the current market price.
    • PIPE Funds refer to Private Investment in Public Equity funds which are funds that invest in publicly-traded companies that are in need of capital but do not want to go through the lengthy and expensive process of a public offering.


Alternative Investment Funds provide a new avenue for investors to diversify their portfolios beyond traditional investments such as stocks and bonds. They offer the potential for high returns, but they also come with higher levels of risk. As a result, it is essential for investors to carefully consider their investment objectives, risk tolerance, and investment horizon before investing in AIFs.

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