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What Is An Alternative Investment And How Does It Work?

Alternative Investment isn’t like some normal investment which is done in assets like bonds, cash etc. These investments are done on assets such as Wine, Artwork Precious metals like diamonds etc. These investments can be also made on Hedge Funds, Private equities etc. Many people who have a high net-worth invest in these kinds of assets which helps in boosting their portfolio. Real estate is one of the popular types of assets in alternative investments, where many rich people invest in apartments and houses to add more assets to their portfolios. Similarly, people also invest in Arts where costly paintings are being bought as an additional asset in the portfolio. One of the main reasons why investors choose alternative investments is to get secured from the risks which are there in traditional investments. When people buy multiple assets like paintings, luxury cars, jewellery etc, rather than cash-based assets, it helps in mitigating the risk in their portfolios. 

With regards to AIF’s regulation, The Securities Exchange Board of India (Alternative Investment Funds) Regulations, 2012 governs all the AIF and defines the main parts involved in it. In India, Alternative Investment Funds (AIF) can be a company, corporate body, Limited Liability Partnership etc.

The Securities Exchange Board of India categorizes AIF into 3 categories:

  1. Category AIF 1 are funds that invest in new startups or new ventures. These help in providing an economic boost for the Startup as well as additional assets in the Investor’s Portfolio. It includes Venture Capital Funds, SME Funds, Angel Funds, Infra Funds and Social Venture Funds. 
  2. Category AIF 2 are funds that invest to satisfy their day-to-day operational needs and they are not used for leverage or borrowings. It includes Real Estate Funds, Funds of Funds, Distressed Asset Fund and Private Equity (PE) Funds. 
  3. Category AIF 3 are funds that invest in both listed derivatives and unlisted derivatives. It includes Hedge Funds and Private Investment in Public Equity Funds. 

Talking about the eligibility for investment in Alternative Investment Funds, Citizens of India, Non-Resident Indians (NRIs), and Citizens of Foreign Nationality can invest in AIF. Apart from eligibility, there is a certain cap in Alternative Investment Funds. In India, Rupees One Crore is the minimum amount of investment which is permitted whereas for employees, directors and fund managers, it is Rupees Twenty Five Lakhs. AIFs generally have a minimum lock-in period of 3 years. 

Now, one question comes to mind: Why should we invest in any Alternative Investment Fund? To answer that, we need to know that whatever funds collected are being invested under the AIF’s investment policy. With SEBI classifying AIFs into three categories, the reasons why should we invest in AIF are as follows:

  1. Diversified Portfolio- Investing in multiple Alternative Investment Funds diversifies the portfolio and helps in becoming tougher. It also helps in making the portfolio less tense.
  2. Lesser volatility- One of the main differences between alternative investments and stocks is that AIFs are less volatile. Thus, AIF becomes a good choice for those who want a stable portfolio. 
  3. Healthier Returns- AIFs offer far better and significant returns than traditional investments
  4. Yielding Income- AIFs helps investors in maintaining a passive income. 

Another reason for choosing AIFs is that they attract taxation benefits. Since these are private fund vehicles, they get money from experienced private investors. The Taxation Rules for the following categories in AIF are as follows:

  1. Category 1 and 2- No tax on earnings since it is a pass-through vehicle. But investors have to give tax on their tax slabs. For example, if Mr X’s fund had capital gains on the stock, then Mr X has to pay at least 15% or 10% which depends on the period of holding. 
  2. Category 3- These AIFs are taxable and they charge at least 42.7%. The Return of Investment is given after-tax deductions to the investors. 

Also, there is a concept of Sponsorship in the AIF. Basically, the person who created and established the AIF is called the sponsor of the AIF. In companies, the promoter is considered as the sponsor whereas, in a Limited Liability partnership, it is the designated partner. 

Hence, with more and more people opting to invest in Alternative investment, it is the future of investments for the reasons mentioned above. It also offers plenty of benefits to the investor and we can be sure that it is a field that will continue to grow in the future.

By Siddhant Dutta