It depends on multiple factors, including financial goals, risk appetite, regulatory requirements, and the type of AIF one is investing in.
AIFs and their categories
AIFs are privately pooled investment vehicles regulated by the Securities and Exchange Board of India (SEBI). They invest in various asset classes such as private equity, venture capital, hedge funds, and debt instruments. AIFs are classified into three broad categories:
Category I AIFs – Invest in startups, small and medium enterprises (SMEs), infrastructure, and other socially or economically beneficial sectors.
Category II AIFs – Include private equity funds, debt funds, and funds that do not undertake leverage except for day-to-day operational purposes.
Category III AIFs – Employ complex trading strategies, including hedge funds, and invest in listed or unlisted securities.
AIF: Investment conditions and restrictions
Before investing in an AIF, let’s understand the regulatory framework governing these funds.
As per SEBI regulations:
Investment Strategy & Alteration – Each AIF must clearly say its investment strategy, purpose, and methodology in its placement memorandum. Any material change in strategy requires approval from at least two-thirds of unit holders by the value of their investments.
Fundraising & Minimum Corpus – AIFs can only raise funds through unit issuance from Indian, foreign, or Non-Resident Indian (NRI) investors. Each scheme must have a minimum corpus of ₹20 crore.
Minimum Investment –
The minimum investment per investor is ₹1 crore.
For employees or directors of the AIF or fund manager, the minimum investment requirement is ₹25 lakh.
Manager/Sponsor Commitment –
The manager or sponsor of an AIF must hold an interest in the fund amounting to the lower of 2.5% of the corpus or ₹5 crore.
For Category III AIFs, this requirement increases to 5% of the corpus or ₹10 crore.
Investor Limit – Each scheme can have a maximum of 1,000 investors.
Fundraising Method – AIFs cannot solicit funds publicly. They can only raise funds through private placements by issuing a placement memorandum.
Disclosure Requirements – The manager and sponsor must disclose their interest in the AIF to investors.
Factors to consider when deciding your corpus for AIF investment
Net worth and asset allocation – HNIs typically follow the 5-20% rule when investing in alternative assets like AIFs. This means they allocate around 5% to 20% of their total investment portfolio to AIFs while maintaining a balance between equities, bonds, real estate, and other assets. AIFs are generally recommended for individuals with a net worth exceeding ₹10 crore, ensuring that even with a ₹1 crore investment, their portfolio remains diversified.
Risk appetite and liquidity needs – AIFs, especially those in Category II and III, involve higher risks compared to traditional mutual funds. They have longer lock-in periods, which can range from 5 to 10 years, making liquidity a major consideration. Investors with a high-risk appetite and a long investment horizon (typically 7-10 years) can consider allocating a larger corpus.
Type of AIF and investment strategy – Each AIF has a different risk-return profile.
Category I– Suitable for investors with a high-risk appetite looking for long-term capital appreciation.
Category II – Moderate to high-risk options that offer stable but potentially illiquid returns.
Category III – High-risk, high-reward investments requiring sophisticated financial understanding.
For conservative investors, Category II AIFs focusing on debt investments may be a safer option. Those with a higher risk tolerance and market expertise might consider Category III hedge funds.
AIF: Tax implications
AIF taxation varies by category:
Category I and II AIFs – The income is taxed at the investor’s end. Investors should factor in capital gains tax when deciding their corpus.
Category III AIFs – Taxed at the fund level at the maximum marginal rate (MMR), often making them less tax-efficient.
Higher investment in Category III AIFs may lead to heavier tax burdens, which should be evaluated before allocating a large corpus.
