Alternative Investment Funds (AIFs)

A Comprehensive Guide | PMS Bazaar

AIF Illustration

What Are
Alternative
Investment
Funds (AIFs)?

What Are Alternative Investment Funds (AIFs)?

Alternative investment funds (AIFs) are investment vehicles that pool funds from sophisticated investors to invest in a broader range of assets compared to traditional options. These can include private equity, venture capital, real estate, infrastructure, commodities, private credit, angel funds, and more.

AIF Illustration

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Why Choose (AIFs)?

Regulation Icon
Well Regulated

The Securities and Exchange Board of India (SEBI), the market regulatory body in India, enforces strict guidelines for Alternative Investment funds, under regulation 2012. These regulations legally bound investor-asset manager relationship fosters transparency and standardisation of services, ultimately creating a more investor-friendly environment.

Diversification Icon
Diversification

Alternative Investments offer portfolio diversification beyond traditional assets by providing access to private credit, real estate, angel funds, global markets and more. These uncorrelated asset classes help reduce risk and enhance long-term wealth creation opportunities for HNI/UHNI Investors.

AIFs Illustration
Expert Icon
Expert Management

Alternative Investment Funds leverage the expertise of qualified and experienced Industry Experts. They meticulously research and select the most promising investment opportunities at their respective asset classes.  But their job doesn't stop there. These managers continuously monitor and assess the portfolio to optimise performance and keep your investments on track towards your wealth creation.

Wealth Icon
Wealth Creation

AIFs unlock exceptional growth potential by helping HNI/UHNI investors access exclusive private market products, which are usually unavailable to traditional investors. Through strategic diversification and professional management, these funds generate superior risk-adjusted returns while maintaining minimal volatility – making them ideal vehicles for sustainable long-term wealth creation.

The Securities and Exchange Board of India (SEBI), the market regulatory body in India, enforces strict guidelines for Alternative Investment funds, under regulation 2012. These regulations legally bound investor-asset manager relationship fosters transparency and standardisation of services, ultimately creating a more investor-friendly environment.

Alternative Investments offer portfolio diversification beyond traditional assets by providing access to private credit, real estate, angel funds, global markets and more. These uncorrelated asset classes help reduce risk and enhance long-term wealth creation opportunities for HNI/UHNI Investors.

Alternative Investment Funds leverage the expertise of qualified and experienced Industry Experts. They meticulously research and select the most promising investment opportunities at their respective asset classes.  But their job doesn't stop there. These managers continuously monitor and assess the portfolio to optimise performance and keep your investments on track towards your wealth creation.

AIFs unlock exceptional growth potential by helping HNI/UHNI investors access exclusive private market products, which are usually unavailable to traditional investors. Through strategic diversification and professional management, these funds generate superior risk-adjusted returns while maintaining minimal volatility – making them ideal vehicles for sustainable long-term wealth creation.

Types of Alternative
Investment Funds (AIFs)?

Type

Criteria
Typical
Strategies
Cons
Taxation
Risk

Category I

bullet Infra, Social, Non-banked Credit for SME
bullet Special incentives provided by the government
bullet Invest in start ups or early stage ventures or social ventures
bullet Socially or economically desirable areas
bullet Venture Capital Funds
bullet SME Funds
bullet Social Venture Funds
bullet Infrastructure Funds
bullet Close ended
bullet Not allowed to leverage
bullet Specific Investment restrictions for each sub type
bullet Pass through
bullet Moderate

Category II

bullet Residual category of funds, invested primarily in unlisted securities
bullet Private Equity Funds
bullet Performing credit funds
bullet Funds of Funds
bullet Other Funds (like Real Estate funds) not classified under the other two categories
bullet Close ended
bullet Not allowed to leverage
bullet No restrictions on asset allocation
bullet Pass through
bullet Medium-high

Category III

bullet Funds which are liquid / listed equities
bullet Funds which may invest in derivatives
bullet Funds which employ leverage for investments
bullet Long Only Equity Funds
bullet Long Short Equity Funds
bullet Open or close ended
bullet Leveraging is allowed up to 2x
bullet No restrictions on asset
bullet Fund level
bullet High

SEBI classifies AIFs into three distinct categories:

1

Category I AIFs

Category I AIFs are designed to support areas deemed socially or economically beneficial by the government. They primarily invest in:

  • Start-Ups and Early-Stage Businesses - These AIFs provide crucial funding to fledgling companies with high growth potential, fostering innovation and entrepreneurship.
  • Infrastructure Funds - They contribute to the development of essential infrastructure projects like roads, bridges, and power plants, driving economic growth.
  • Small and Medium Enterprises (SMEs) - Category I AIFs can provide much-needed capital to SMEs, fueling their expansion and job creation.

These AIFs often employ venture capital and private equity strategies, where they invest directly in companies or acquire equity stakes. They play a vital role in nurturing promising businesses and fostering economic progress.

2

Category II AIFs

Category II AIFs do not fall under Category I or III and are typically used for long-term. Category II AIFs are the biggest Category of the AIF industry, holding over 75% of total commitments raised.

  • Private Equity Funds - These invest in unlisted companies with proven business models that are ready to scale.
  • Performing Credit Funds - These provide structured debt to companies, usually in the form of non-convertible debentures or mezzanine loans.
  • Real Estate Funds – Invest in commercial and residential projects to generate regular interest.
  • Secondaries Funds – Buy stakes from existing investors in AIFs or private companies, often acquiring assets at a discount.
  • Pre-IPO Funds – Invest in companies just before they go public to capitalize on valuation growth.

These are just some of the popular strategies. Category II AIFs cover many more themes like Infrastructure, Special situations, stressed assets & More.

3

Category III AIFs

Category III AIFs offer the most flexibility in terms of investment strategies. They can invest in a wider range of assets compared to the other categories, including:

  • Long-Only Equity - These funds invest in equity (stocks) with the expectation that prices will rise over time.
  • Long–Short Equity - These AIFs invest in stocks expected to rise (long positions) and simultaneously sell stocks expected to fall (short positions).

Category III AIFs utilise a broad spectrum of investment strategies, depending on the specific fund's objective. They offer the potential for high returns but also carry the highest risk profile.

Features of AIFs

Exclusive Strategies

Exclusive
Strategies

Access to unique, expert-driven investment ideas not available in traditional investments.

Limited Customization

Limited
Customization

Unlike PMS, AIFs aren't tailored to individuals but still offer focused thematic strategies.

Transparent Reporting

Transparent
Reporting

Investors receive regular performance and portfolio updates.

Long-term Commitment

Long-Term
Commitment

Typically closed-ended with multi-year lock-ins – AIFs lock in for 3–10 years; Category II targets high returns by investing in aggressive asset classes.

How Do Alternative
Investment  Funds (AIFs) Work? 

1

Investor Participation:

HNIs and institutions invest in AIFs with a minimum investment of ₹1 crore.

2

Pooling of Funds:

Capital is pooled into a structured fund managed by professionals.

2

Investment Allocation:

Alternative Investment Funds (AIFs) operate at a pooled investment level, where funds are collected from multiple investors and managed collectively.

4

Returns & Exits:

Investors receive returns through capital appreciation, dividends, interest or exit strategies. 

At PMS Bazaar, we guide investors through every step of AIF investing, ensuring
transparency and optimal fund selection. 

Eligibility to Invest in AIFs:
Who Can Benefit?

AIFs cater to sophisticated investors who understand the inherent risks and can commit to longer investment horizons, including:

  • High-net-worth individuals (HNIs)
  • Institutional investors
  • Family offices
  • Corporations and financial institutions
  • NRIs and HUFs can also invest, subject to regulatory norms.
Minimum Investment Requirement
₹1 crore for individual investors

Before investing in AIFs, it’s important to understand key factors that influence your decision-making. Explore the key considerations every investor should know.

AIFs Illustration

AIFs cater to sophisticated investors who understand the inherent risks and can commit to longer investment horizons, including:

AIFs Illustration
  • High-net-worth individuals (HNIs)
  • Institutional investors
  • Family offices
  • Corporations and financial institutions
  • NRIs and HUFs can also invest, subject to regulatory norms.
Minimum Investment Requirement
₹1 crore for individual investors

Before investing in AIFs, it’s important to understand key factors that influence your decision-making. Explore the key considerations every investor should know.

Learn More

Risks and Returns:
Is Investing in AIFs Worth It?

AIFs Illustration

Potential Returns
AIFs have historically outperformed traditional investments,delivering superior returns by leveraging specialized investment strategies in alternative Asset.

    Risks to Consider

  • alert Market Risk: Like any investment, AIFs are subject to market fluctuations, which can lead to losses. This is probably standard for all market-linked investments.

  • alert Liquidity Risk: The lock-in period associated with these funds can limit liquidity compared to some traditional investment avenues.

  • alert Managerial Risk: The performance of the AIF heavily relies on the skills and decisions of the fund manager. This is not exclusive to this category.

  • alert Aggressive Asset Class Risks: AIFs often invest in high-growth opportunities like SMEs, private equity, and venture capital. While these offer higher return potential, they also carry greater risk and volatility.

AIFs Illustration

Potential Returns
AIFs have historically outperformed traditional investments,delivering superior returns by leveraging specialized investment strategies in alternative Asset.

    Risks to Consider

  • ♦ Market Risk: Like any investment, AIFs are subject to market fluctuations, which can lead to losses. This is probably standard for all market-linked investments.

  • ♦ Liquidity Risk: The lock-in period associated with these funds can limit liquidity compared to some traditional investment avenues.

  • ♦ Managerial Risk: The performance of the AIF heavily relies on the skills and decisions of the fund manager. This is not exclusive to this category.

  • ♦ Aggressive Asset Class Risks: AIFs often invest in high-growth opportunities like SMEs, private equity, and venture capital. While these offer higher return potential, they also carry greater risk and volatility.

PMS Bazaar offers expert insights to help investors mitigate risks and maximize returns.

Taxation of AIFs in India:
What Investors Need to Know

Category I & II AIFs
Pass-through taxation: Investors pay tax based on individual income tax slabs.

Category III AIFs
Fund-level taxation: The AIF is taxed on gains before distributing returns. 

AIFs Illustration

Benefits of Alternative Investment Funds

  • Diversification Beyond Conventional Assets: Alternative Investment Funds provide sophisticated investors access to a universe beyond traditional stocks and bonds, offering true portfolio diversification through assets with low correlation to conventional markets.

  • Superior Return Potential: AIFs offer the possibility of higher returns compared to traditional options by accessing unique opportunities in private markets, though they come with correspondingly higher risk profiles that must be carefully evaluated

  • Exclusive Investment Opportunities: AIFs enable access to promising startups, unlisted companies, and specialized markets that would otherwise be inaccessible through conventional investment channels, creating potential for early-stage growth participation. Strategic Portfolio Protection: The low correlation between alternative assets and traditional investments acts as a buffer during market downturns, potentially reducing overall portfolio volatility and providing more stable long-term performance.

  • Professional Expertise: AIFs are managed by seasoned professionals with specialized knowledge in specific sectors or strategies, allowing them to navigate complex market conditions and identify unique opportunities beyond retail investors' reach.

  • Innovative investment approaches:  With a minimum investment threshold of ₹ 1 crore, AIFs cater to sophisticated investors who possess both the financial capacity and market understanding to benefit from complex investment strategies and longer investment horizons.

  • Access to Differentiated Alpha Sources: As public markets become increasingly saturated and competitive, AIFs provide access to non-traditional and less-explored avenues for alpha generation, helping investors uncover hidden value and outperform market benchmarks.

Discover how Alternative Investment Funds can add depth and diversification to your investment portfolio.

Learn More

PMS vs AIF Comparison

Features PMS (Portfolio Management Services) AIF (Alternative Investment Funds)
Strategy Focus Tailored strategies based on individual goals Access to niche, pooled strategies not available in Traditional investments.
Customization High – portfolio built around investor preferences Low – uniform strategy for all investors
Reporting Frequent and detailed performance reports Periodic (typically quarterly/semi-annual)
Approaches No pooling of investor funds. A separate Demat account is maintained for every client. Investor money is pooled and then invested as per investment scheme
Minimum Investment ₹50 lakhs (SEBI minimum) ₹1 crore (SEBI minimum)
Risk Moderate to high Moderate to high (varies by fund type)
Taxation Taxation for PMS is similar to that of direct equity investments, with capital gains taxed based on whether they are short-term or long-term Category I & II – Pass-through Taxation and Category III – Fund-level taxation
Investor Profile HNIs, experienced investors HNIs, ultra-HNIs, and sophisticated investors

FAQs on Alternative Investment Funds (AIFs)

AIFs are privately pooled investment vehicles that invest in non-traditional assets like private equity, venture capital, real estate, and hedge funds, regulated by SEBI to provide sophisticated investors access to diversified investment opportunities.

AIFs cater to HNIs and institutional investors with high-risk, high-return strategies, whereas mutual funds are more liquid and suitable for retail investors.

Only HNIs (min ₹1 crore investment), institutions, and corporate investors can invest in AIFs. 

AIFs (Alternative Investment Funds) are classified into three main categories:

Category I: Invest in sectors with strong social and economic impact like start-ups, SMEs, infrastructure, and social ventures. Supported by regulators for aiding nation-building and job creation. Ideal for long-term investors focused on growth with purpose — including green energy, affordable housing, and more.

Category II: The largest and most popular category of Alternative Investment Funds, preferred by Ultra-HNIs and institutional investors for access to exclusive investment opportunities such as private equity, performing credit, special situations, stressed assets, real estate, and more.

Category III: Designed for short- to medium-term returns through active trading in public markets using long-short equity, arbitrage, derivatives, and leverage. Suitable for investors with a high-risk appetite seeking absolute returns — includes hedge funds, tactical strategies, and more.

Taxation depends on the category. Category I & II AIFs follow a pass-through structure where income retains its character and is taxed in the hands of investors. Category III AIFs are typically taxed at the fund level before distributing returns.

Yes, AIFs can give higher returns than traditional investments because they invest in unique opportunities and use advanced strategies. But they also come with more risk, longer lock-in periods, and less liquidity. So, they are better suited for investors who are okay with taking higher risks for better returns.

At PMS Bazaar, we offer expert guidance, fund comparisons, and investment strategies to help you choose the right AIF. Speak to an AIF Expert.

Yes, there is a lock-in period for AIFs. It depends on the fund. Category I and Category II are compulsory close-ended funds with a tenure of 3 to 10 years. Category III can be either close-ended or open-ended.

Early exits are not usually permitted due to the closed-ended structure. However, some funds may allow secondary transfers to eligible investors, subject to fund terms and SEBI guidelines. Liquidity before maturity is very limited, so investors should plan accordingly.

Yes, the minimum investment commitment can be paid in multiple tranches; however, the structure and schedule are determined by the specific fund. Typically, open-ended AIFs require the full commitment (₹1 crore) upfront, while closed-ended AIFs may collect the amount in tranches. Investors should confirm the payment terms with the fund before investing.