Alternative investment funds were formally introduced in Indian market in 2012 by SEBI. Alternative investment funds provide investors an option to invest in non-traditional financial products. Over the period alternative investment funds gained popularity and currently around 900 funds are there in India.
What is alternative investment funds?
Alternative investment fund is a privately pooled fund, where well-learned and sophisticated investors invest their money. The investor can be Indian or foreign origin. It is governed by the SEBI (Alternative Investment Funds) Regulations 2012 and NOT covered by SEBI (Mutual Funds) Regulations 1996.
What are the categories of alternative investment funds?
There are 3 categories of alternative investment funds.
Category I
It includes the followings
Venture capital fund (including angel fund)
It is a fund which invest as equity in start-ups and small to medium sized enterprises with strong growth potential. This kind of investment carry high risk at the same time potential of high return.
Angel fund is part of venture capital fund. Angel fund take investment only from Angel investor. As per alternative investment fund regulations an angel investor is
- an individual with i) net tangible assets of ₹2 crore excluding his principal residence, ii) experienced as early-stage investor, iii) experienced as serial entrepreneur and iv) experience of 10 years as senior management.
- A body corporate with a networth of at least ₹10 crore.
SME Funds
SME (Small and Medium Enterprise) Fund is an Alternative Investment Funds which invest as equity in listed or unlisted SME entities. As per regulation minimum investment should be ₹1 crore for a tenure of 3 years. It can be extended for another 2 years. Further, SME Fund need to invest 75% of its corpus in listed, to-be-listed or unlisted SME companies. Currently, corpus under this fund is ₹290 crore.
Social venture Funds
It is an alternative investment funds which invest 75% or more of its corpus in unlisted entities engaged in socially good activities. As per SEBI guidelines such entities should be ‘not for profit’. However, SEBI is working to revise this guideline to attract more investors. Currently, corpus under this fund is ₹578 crore.
Infrastructure funds
It is a sector specific private equity fund, which invest in companies engaged in public assets and services that are essential for a society like power, transport, water, waste management etc.
Category II
The category II alternative investment funds invest in areas which are not covered under category I and III like distress assets, real estate funds, private equity funds, debt fund etc. This category does not leverage borrowings.
Category III
This category of alternative Investment funds may leverage borrowings and invest in diverse trading strategies including listed or unlisted derivatives. Various type of funds such as hedge fund, PIPE (private investment in public equity) funds etc are example.
Who is a sponsor of alternative investment funds?
A sponsor can be anybody who propose to set up an alternative investment fund. As per regulation sponsor/manager need to maintain a certain continuing interest in the fund. For category I and II, such interest must not be less than 2.5% of the corpus or ₹5 crore. For category III, the interest must not be less than 5 % of the corpus or ₹10 crore. For angel fund such interest shall be not less than 2.5% or ₹50 lakh.
How alternative Investment funds is offered?
There are certain regulation for offering this kind of funds.
Regulation related to the fund
- Alternative investment funds can be set up as a trust, LLP or company.
- Funds are raised from investor based on a written contract on a specific date.
- No alternative investment fund can have more than 1000 investors except angel fund where 49 angel investors can participate.
- Fund has to be raised by private placement only, no public invitation.
- The fund house has to file the placement memorandum with SEBI before raising funds from investors.
- The corpus value should be atleast ₹20 crore, angel fund ₹10 crore.
- Per investor value should be atleast ₹1 crore. Investment of employee or Director of of the fund house should be minimum ₹25 lakh.
- Full disclosure should be made about the fund.
- SEBI registered custodian should be appointed for safekeeping of securities.
- Conflict of interest should be disclosed as when arise.
- Change in key investment team should be intimated to investors.
- Investment advisor should have requisite qualification as per SEBI guidelines.
- Corporate investment advisor should have minimum networth of ₹2.5 crore.
- Investment advisor shall carry out risk analysis of the investor and intimate the same.
Regulation related to disclosure
The private placement memorandum must contain all material information about the fund, including:
- the minimum commitment size.
- the background of the key investment team.
- the target investors.
- the fees and other expenses proposed to be charged.
- the target size of the fund
- the tenure of the fund.
- conditions and limitations with respect to the redemption.
- the investment objective and strategy.
- risk management tools and the parameters employed.
- key service providers.
- conflict of interest and procedures to identify and address the same.
- disciplinary history.
- the terms and conditions of the fund manager.
- the fund or scheme winding up plan and
- any other such information as may be required for the investor to make an informed decision on whether to invest in the fund.
How redemption happens in alternative investment fund?
The placement memorandum gives details about investment conditions including redemption option. Generally, such funds carry lock in period of 3 years.
Redemption are allowed only in the case of open-ended funds (i.e, Category III). Under exceptional circumstances, the redemption may be suspended. However, it has to be justified by the manager that such suspension is exclusively in the best interests of investors or is required under the regulations or by the SEBI.
What are the restrictions for alternative investment fund?
In terms of investment restrictions, a general diversification restriction is imposed whereby Category I and Category II funds can invest only the maximum of 25% of their ‘investible funds’ in a single portfolio company and Category III funds are further restricted investing a maximum of 10% of their investible funds in a single portfolio investment.
Category I and Category II funds are not permitted to borrow funds directly or indirectly, or to engage in any leverage except for meeting temporary funding requirements for not more than 30 days and not more than four occasions per year and of not more than 10% of their investible funds.
Restrictions for Category I funds
- At least two-thirds of their investible funds must be invested in unlisted equity shares or equity-linked instruments of a venture capital undertaking or in companies listed or proposed to be listed on a small and medium-sized enterprise (SME) exchange
- Not more than one-third of their investible funds must be invested in:
- the initial public offering of a venture capital undertaking proposed to be listed;
- debt instruments of a venture capital undertaking;
- preferential allotment of equity or equity linked instruments of a listed company;
- equity or equity-linked instruments of a financially weak company – that is, a company whose accumulated losses had eroded more than 50% of its net worth as at the beginning of the previous financial year; or
- special purpose vehicles which are created by the fund for the purpose of facilitating investment in accordance with the AIF Regulations.
Restriction on category II funds
At least 50% of their investible funds must be invested in unlisted investee companies.
Restriction on category III funds:
No portfolio allocation restrictions apply, apart from the general diversification requirement captured above. This category of fund is permitted to invest in listed or unlisted investee companies or derivatives or complex or structured products; and to deal in goods received in delivery against physical settlement of commodity derivatives.
Why alternative investment fund is beneficial?
Following are the major benefits of investing in alternative investment funds
Non traditional portfolio
The invest in this kind of fund is unique and different from the traditional investment product like equity, mutual fund etc. It is about betting on entrepreneur, business idea and prospective growth. Performance of the fund is not linked to stock market, which is exposed to many factors. Therefore, the fund manager has many flexibility while building the portfolio.
Shield Against Volatility
The investments undertaken by such fund are unrelated or less related to the stock market. Thus, their returns do not fluctuate owing to the ups and downs in the stock market. Furthermore, as alternative investment fund do not allocate funds to investments that trade publicly, unit-holders do not have to tolerate share price fluctuations. So, investment in such fund are less volatile and comparatively stable.
Reasonable Returns
Due to their investment strategy, these funds generate higher returns compared to many traditional instruments like debentures or bonds. Furthermore, due to minimal dependency on the stock market, the chances of return fluctuations are also less.
There are many Alternative investment option available in the market. Alternative investment fund is one of them. Though this option is open to selective investors, a right choice can definitely given very high returns.