What are Category III AIFs and who should invest in them?

An Alternative Investment Fund (AIF) is a privately pooled investment vehicle in India that collects funds from sophisticated investors (both Indian and foreign). While there are three categories in AIFs, one of the most popular in this segment is Category III AIFs.

Category III AIFs deploy advanced investment techniques, including complex trading strategies, to manage investments. These are preferred by investors for their high returns and significant diversification.

AIFs are different from mutual funds and other regulated funds under the market regulator – the Securities and Exchange Board of India (SEBI). Moreover, certain funds are also exempt from AIF registration under specific conditions. These include family trusts and employee welfare or gratuity trusts.

Besides Category III, registration under AIF is also done in Category I and II, which are less aggressive and have their focus areas of investment. Category III AIFs include funds like hedge funds, a term which has gained a lot of attention lately. They may also borrow money (leverage) to increase the amount they can invest and are considered a high-risk investment.
Where do Category III AIFs invest in?

These funds invest in listed as well as unlisted companies, derivatives, and structured products. Funds in this category are also bounded by how much they can invest in any single investee company, according to the SEBI rules. There are two types of funds within this segment: open-ended and close-ended. While open-ended funds offer more flexibility, close-ended structured funds lock in investments for a specified maturity period. These funds are typically seen as long-term investments. Open-ended funds provide liquidity but often carry exit loads.

Who Should Invest in Category III AIFs?

These investment vehicles act differently from traditional equities, bonds, and mutual funds. They are preferred for their diversification and high return potential, especially for long-term investors. With limited correlation to traditional assets, they help diversify investment portfolios. Typically, Qualified Institutional Investors (QIIs), and high-net-worth individuals (HNIs) invest in AIFs.

Due to their high-risk nature, AIFs involve greater exposure to alternative assets, which can lead to higher returns but also higher risks, the National Stock Exchange explains. Before investing in an AIF, it’s important to consider factors such as choosing a reputable AMC with a proven track record and carefully considering your investment goals and risk tolerance before investing.

The minimum amount required to invest in an AIF is ₹ 1 crore.