Key takeaways
- An AIF is a privately pooled investment fund registered with SEBI under the AIF Regulations, 2012 — used for strategies that mutual funds and PMS can’t or don’t offer.
- Category I funds back start-ups, SMEs, infrastructure and social ventures; Category II covers private equity, private credit and real estate; Category III runs complex, often hedged strategies in listed markets.
- The minimum investment is ₹1 crore for most investors.
- Category I and II funds are closed-ended, with a minimum tenure of three years, and usually draw your commitment in stages. Category III funds can be open- or closed-ended.
- Category I and II funds are “pass-through” for tax, while Category III funds are taxed at the fund level — a key difference when comparing returns.
What is an Alternative Investment Fund?
An Alternative Investment Fund (AIF) is a privately pooled investment vehicle that collects money from sophisticated investors and invests it according to a defined strategy. AIFs are regulated by SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012.
“Alternative” means the fund invests outside the traditional route of publicly offered mutual funds — in unlisted companies, private debt or real estate, or through trading strategies such as long-short equity that use derivatives. AIFs raise money through a private placement memorandum (PPM) rather than a public offer, and are built for investors who can accept higher risk, lower liquidity and longer lock-ins.
The three categories at a glance
| Category I | Category II | Category III | |
|---|---|---|---|
| What they invest in | Start-ups and early-stage ventures, SMEs, social ventures, infrastructure | Private equity, private credit, real estate, funds of funds | Listed equities and derivatives, using diverse or complex trading strategies |
| Common examples | Venture capital funds, angel funds, SME funds | PE funds, pre-IPO funds, performing-credit and special-situations funds | Long-short, long-only, arbitrage, quantitative and options strategies |
| Structure | Closed-ended; minimum tenure 3 years | Closed-ended; minimum tenure 3 years | Open- or closed-ended |
| Leverage | Only for day-to-day operational needs | Only for day-to-day operational needs | Permitted, within SEBI limits |
| Tax treatment | Pass-through to investors (except business income) | Pass-through to investors (except business income) | Taxed at the fund level |
Category I: backing the real economy
Category I AIFs invest in areas the government considers economically or socially desirable — start-ups, early-stage ventures, SMEs, social enterprises and infrastructure. Venture capital funds and angel funds fall here.
Returns tend to come from a handful of breakout companies, so outcomes are widely dispersed and timelines are long — often seven to ten years before capital is fully returned.
Category II: private equity and private credit
Category II covers funds that don’t fit Category I or III and don’t borrow except for day-to-day needs. Private equity, pre-IPO, private credit, real estate and fund-of-funds strategies typically sit here, and it is the largest category by commitments.
Most Category II funds work on a commitment and drawdown model: you commit, say, ₹1 crore, and the manager draws it down in tranches as opportunities arise, then returns capital as investments are exited. Undrawn money stays with you until it is called.
Category III: hedge-fund strategies
Category III AIFs employ diverse or complex trading strategies and may use leverage, including through listed or unlisted derivatives. They are the closest Indian equivalent of hedge funds — see our full guide to hedge funds in India.
Leverage is capped at two times the fund’s net asset value. Many Category III funds are open-ended, offering periodic liquidity subject to exit loads and notice periods.
Minimum investment and eligibility
- The minimum investment is ₹1 crore per investor (₹25 lakh for employees or directors of the fund or its manager, and for angel funds).
- A scheme can have at most 1,000 investors (200 for angel funds).
- Sponsors or managers must keep their own money in the fund: the lower of 2.5% of the corpus or ₹5 crore for Category I and II, and the lower of 5% or ₹10 crore for Category III — an alignment of interest investors should welcome.
How AIFs charge
AIF fees vary widely and are set out in the PPM. The most common structure is a management fee of roughly 1.5% to 2.5% a year plus a performance fee or carried interest — often 10% to 20% of profits above a hurdle rate. In closed-ended funds, carry is usually paid only after investors have received their capital back plus the hurdle.
Also check set-up costs, ongoing fund expenses, and whether fees are charged on committed or invested capital. Our fees guide explains each term with worked examples.
Liquidity and lock-in
Liquidity is the biggest practical difference between AIFs and listed-market products:
- Category I and II funds are closed-ended. You typically can’t redeem before the fund winds up, and tenure can be extended — usually by up to two years with investor approval.
- Category III funds may be open-ended, with monthly or quarterly redemption windows, exit loads and notice periods — or closed-ended with a fixed term.
- Units can be transferred only in limited cases, and there is no ready secondary market.
Taxation in brief
Category I and II AIFs have pass-through status: income such as capital gains, interest and dividends is taxed in your hands as if you had earned it directly (business income is the exception, taxed at the fund). The fund deducts tax at source on distributions to resident investors.
Category III AIFs do not have pass-through status. They are taxed at the fund level — often at the maximum marginal rate — and what they distribute is then generally not taxed again. That is why Category III returns are usually reported after tax, while PMS returns are shown before tax. See how PMS and AIFs are taxed.
Who should consider an AIF?
- Investors with substantial investable wealth, for whom ₹1 crore is a measured allocation rather than a large share of net worth.
- Investors who can accept illiquidity for several years in exchange for access to private markets.
- Families and individuals who want return drivers — private companies, private credit, hedged strategies — that behave differently from listed equities.
Weighing an AIF against a PMS? Read PMS vs AIF. When you are ready, our page on how to invest in an AIF walks through commitments, drawdowns and paperwork.
Frequently asked questions
What is the minimum investment in an AIF?
₹1 crore for most investors. Employees and directors of the fund or its manager, and investors in angel funds, can invest ₹25 lakh.
Which AIF category is best?
No category is best in general. Category I and II suit long-horizon investors seeking private-market returns; Category III suits those who want professionally managed, often hedged, listed-market strategies with better liquidity. The right mix depends on your goals, liquidity needs and existing portfolio.
Can I exit an AIF early?
Category I and II funds are closed-ended, so early exit is generally not possible. Open-ended Category III funds offer periodic redemption, subject to the exit loads and notice periods in the PPM.
Are AIFs safe?
AIFs are regulated by SEBI, but regulation does not remove investment risk. They can be illiquid and concentrated, and they can lose money. Read the PPM carefully and invest only what you can leave untouched for the full tenure.
Can NRIs invest in AIFs?
Yes. NRIs can invest in Indian AIFs subject to KYC and FEMA requirements, or in USD-denominated funds set up in GIFT City.
