The alternate investment industry of India has developed into something that truly is a big business in its own right – SEBI-registered AIFs have assets under management amounting to several lakh crore rupees worth of investments across thousands of registered schemes. As a high net worth individual investor, if you were to look at avenues other than mutual funds and stocks for your investments, you would surely have heard of the acronym “AIF”. However, “AIF” does not refer to one particular product but three completely different types of funds altogether.
This guide provides you with information about the best AIF funds in India, categorized wise and also about how each of the different types work, and helps you understand how to select the top 10 AIF funds in India.
What Is an Alternative Investment Fund (AIF)?
Alternative Investment Fund is an alternative investment vehicle in the country created and structured as an investment fund and registered with SEBI as per the SEBI (Alternative Investment Funds) Regulations, 2012. While mutual funds welcome retail investors in small investments, AIFs cater to sophisticated investors, as the minimum investment in AIFs is ₹1 crore per investor, thus narrowing down the investor profile to wealthy individuals and families, and institutions only.
SEBI has classified AIFs into three broad categories, and this classification serves as the primary benchmark to help investors select the right alternative investment funds in India.
The Three Categories of AIFs in India
Category I AIF: The Growth Builders
Category I AIFs include investments in industries that the government finds economically and socially desirable — venture capital funds, SME funds, infrastructure funds, angel funds, and social impact funds, to name a few. Most of these funds are usually closed-ended and operate for at least three years, with no scope for leverage.
Since they are invested in early-stage companies, startups, and infrastructural projects, the gains come only after a period of one to three years. Once their bets pay off, however, these Category I funds provide one of the best opportunities for investors to generate the most returns in all three AIF categories due to their early investment stage.
Investors for Category I AIFs: Those with a long-term view, high-risk profile, and the patience to stay in illiquid assets.
Category II AIF: Where Most Serious AIF Money Goes
Category II is the biggest and most popular category in India, garnering by far the largest share of total AIF investments across the nation. In essence, Category II serves as a residual category for AIFs that do not fall into Category I and Category III, which in effect translates into private equity funds, debt funds, real estate funds, and structured credit platforms.
What makes Category II appealing is the diversity in its risk profile. At the lower end of the spectrum, there are private credit funds that finance medium-sized businesses with secured loans backed up by collateral – these are generally the safer bet among all others in this category. Conversely, at the higher end, there are growth-focused private equity funds invested in companies with great potential in areas like manufacturing and alternative energy.
Category II AIFs too have closed ends with a tenure ranging from five to seven years. Just like Category I AIFs, these too offer pass-through taxation wherein the profits are taxed in the hands of the investors, not the fund, thus giving an edge over Category III AIFs.
Suitable for Category II AIFs: Those individuals who wish to get invested in private markets (private equity, real estate, private credit) and wish to customize their risk comfort level.
Category III AIF: The Sophisticated, Hedge-Fund-Style Strategy
AIFs Category III are the most complicated type among the three categories. They operate with similar methods of investment as those applied by global hedge funds — namely, long-only, long/short, derivatives and leveraged. This type usually operates in listed securities but there has been an increase in Category III AIFs that are venturing into private markets.
What makes this category different from Category I and II is that Category III is capable of being more flexible in their portfolio management because they can re-balance the portfolios; they can react quickly to the market disturbances; they can use leverage to their advantage. Some funds in this category are open-ended and thus provide higher liquidity compared to those found in Categories I and II.
The downside of Category III funds is that they cannot benefit from pass-through taxation as such. It means that tax must be paid at the fund level, resulting in an increased tax drag.
Who should consider investing in Category III AIFs? Those investors who already have investments in listed equity.
How to Identify the Best AIFs in India
Don’t go for the temptation of ranking any mutual fund purely based on its performance the previous year. This is because one good year does not tell you anything about the performance, consistency, and risk management ability of the mutual fund manager. The parameters to look at are:
Track Record Through Cycles Consider how the fund – and more importantly, the fund manager – has done in all cycles, including not only bull cycles but also bear cycles, and not just in a favorable 12 months period.
Category Suitability for Your Needs Even a category I venture fund with great performance is not necessarily right for you, if you plan to sell your stake within 24 months. Compare only the funds with similar structures to your needs.
Fee Structure An Alternative Investment Fund charges a management fee and carry above a hurdle rate. Remember about the overall fee structure because even high fees could silently reduce otherwise good performance results.
Liquidity Categories I and II Funds are generally illiquid until exit, whereas the liquidity of Category III funds is vastly different from strategy to strategy; some have open-ended structures with redemptions at fixed intervals while some remain locked up for years.
Fund Manager’s Method, Rather Than Just the Name The AIFs’ performance varies widely, even among funds belonging to the same SEBI category. What is more important is the process followed by the fund manager and his entry/exit rules.
Compliance and Transparency Choose only those AIFs which are fully SEBI registered and disclose their portfolio, valuation, and performance.
A Practical Approach to Shortlisting Top 10 AIF Funds in India
Instead of going for the dynamic “top 10” list, which keeps changing from quarter to quarter as the fund performance and fundraising varies, the better way is to make your own shortlist of funds through the following process:
- Select based on the category. Do you want early-stage growth experience (Category I), diversified private market experience (Category II), or listed-market expertise (Category III)?
- Select based on the sub-strategy. Even within the second category, there are private equity, private credit, and real estate debt funds – all quite different in nature.
- Compare based on the AUM and vintage. The longer track record and the more the AUM, the more data is available for consideration.
- Ask for performance data after auditing. Legitimate AIFs would not mind giving you the SEBI compliant performance data – don’t depend only on marketing documents.
- Speak to a SEBI registered investment adviser. Considering the ₹1 crore minimum requirement, and the complexity of these products, seeking professional advice before investing is essential.
Category I vs II vs III: Quick Comparison
| Factor | Category I | Category II | Category III |
| Typical Investments | VC, SME, infrastructure, angel funds | PE, debt, real estate | Listed equity, derivatives, leveraged strategies |
| Structure | Close-ended | Close-ended | Open or close-ended |
| Leverage | Not permitted | Limited to operational needs | Permitted |
| Taxation | Pass-through | Pass-through | Taxed at fund level |
| Liquidity | Low | Low to moderate | Varies, generally higher |
| Time Horizon | 5-7+ years | 5-7 years | Shorter, more flexible |
Final Thoughts
There is no such thing as one single perfect AIF for all investors. Depending on your risk tolerance level, investment horizon, and the role of alternatives in your investment portfolio, one of the three categories would be suitable for you.
Before investing, do not just look at the numbers. You should investigate the processes of the fund manager, learn about the fees associated, assure that the liquidity conditions of the fund fit yours, and assure that the fund is registered by SEBI.
The best AIF in India may not be those that generate most buzz but those which perfectly suit your investment aims in their strategy, risk, and structure.
If you feel uncertain about which category or which particular fund fits your financial objectives, then contacting an investment advisor will be the safe first move to make.
Frequently Asked Questions (FAQs)
What are the best alternative investments in India?
Non-traditional assets governed primarily by the Securities and Exchange Board of India (SEBI) or designed for high-net-worth and retail investors are examples of alternative investments in India.
Is Aif better than mf?
Neither a mutual fund (MF) nor an alternative investment fund (AIF) are inherently “better”; they are designed for very different investor profiles, risk tolerances, and capital needs.
Is AIF better than mutual fund?
Mutual funds and Alternative Investment Funds (AIFs) are not inherently “better”; rather, they cater to entirely different investor types, capital levels, and financial objectives.
What is the current AIF return rate?
Because performance varies greatly by category, fund strategy, market conditions, and vintage year, alternative investment funds (AIFs) in India do not have a single fixed return rate.
What are the top 5 funds of funds in India?
Taking into consideration the performances and assets under management (AUM) ranks of recent years in India, some of the most successful and popular Fund of Funds (FoF) schemes are as follows:
- HDFC Income Plus Arbitrage Active FOF Fund
- ICICI Prudential Dynamic Asset Allocation Active FOF Fund
- Nippon India Multi Asset Omni FoF Fund
- Mirae Asset Equity Allocator Fund of Fund
- Motilal Oswal Nasdaq 100 Fund of Fund
What is cat1, cat2, and cat3 in aif?
In accordance with the SEBI’s regulations of the Alternative Investment Fund (AIF) Regulations, 2012, there are three types of AIFs classified based on their strategy and risk profile:
Category I AIF: It invests in new ventures, early-stage ventures, SMEs, social ventures, infrastructure and any other sector which is socially or economically beneficial. This includes Venture Capital Funds, Angel Funds, SME Funds, Social Venture Funds and Infrastructure Funds. Such funds may be given some concessions by the Government.
Category II AIF: This type includes any fund which does not fall under Type I or Type III AIFs. It does not employ leverage except for daily operation purposes and does not have any special concession. Some examples of such funds are Private Equity Funds, Debt Funds and Funds of Funds.
Category III AIF: This uses a variety of sophisticated trading strategies and may employ leverage through the use of derivatives. Some examples of such funds are Hedge Funds and PIPE (Private Investment in Public Equity) Funds.