Overview & Setting up AIFs in India

Alternative Investment Funds (AIFs) registered with the Securities and Exchange Board of India (SEBI) have been growing steadily, indicating a significant interest in this investment vehicle across various categories. SEBI introduced the AIF regulations in 2012 to regulate private funds that were previously not under any particular regulatory framework. These funds invest in non-traditional asset classes such as startups, infrastructure, and alternative investments.

Overview of AIFs in India

AIFs are classified into three categories based on their investment objectives:

1. Category I AIFs: These funds are focused on investing in sectors or industries that the government or regulators consider socially or economically desirable, such as venture capital, social ventures, infrastructure, and small and medium enterprises (SMEs).
2. Category II AIFs: These funds can invest in a wide range of assets, including private equity and debt. They do not undertake leverage except for day-to-day operational purposes. Private equity and debt funds generally fall under this category.
3. Category III AIFs: These are hedge funds or funds that employ complex strategies, such as investing in derivatives and taking long-short positions. They can employ leverage to enhance returns.

Growth in AIF Registrations

The number of AIFs registered with SEBI has increased significantly since the introduction of the AIF regulations. Here are some notable trends and statistics regarding AIF registrations:

1. Total Number of Registered AIFs:
   • As of the end of 2023, there were approximately 1,150 registered AIFs across all three categories.
   • This is a marked increase from around 700 registered AIFs in 2020, showing a growing preference among investors for alternative investment strategies.
2. Category-Wise Breakdown:
   • Category I AIFs: Comprise funds such as venture capital funds (VCFs), infrastructure funds, and social venture funds. As of the latest data, approximately 100-150 Category I AIFs are registered with SEBI.
   • Category II AIFs: This category dominates the AIF space in India, with over 700 funds. These funds primarily focus on private equity and debt investments and do not employ leverage.
   • Category III AIFs: There are around 250-300 Category III AIFs registered, making up a substantial part of the AIF market, as these funds use sophisticated investment strategies such as hedge funds and employ leverage to enhance returns.

3. Year-wise Growth in AIF Registrations:

   • Number of AIFs registered from 2012 to 2023, highlights the spike in registrations after regulatory changes or market conditions that spurred interest.
   • Example:
     • 2012: 10 AIFs
     • 2015: 120 AIFs
     • 2020: 670 AIFs
     • 2023: 1,150 AIFs (approx.)

4. Category-wise Distribution of AIFs:

   • Break the total number of AIFs registered by category provides clarity on investor preferences for specific types of funds. As of 2023:
     • Category I AIFs: ~150
     • Category II AIFs: ~700
     • Category III AIFs: ~300

   Year	Total AIFs	Category I	Category II	Category III
   2012	10	3	5	2
   2015	120	15	70	35
   2020	670	80	450	140
   2023	1,150	150	700	300

5. Sectoral Focus:
   • AIFs in Category I have been actively investing in early-stage startups and infrastructure projects, aligning with the government’s push towards innovation and infrastructure development.
   • Category II AIFs focus heavily on private equity, investing in growing companies across sectors like technology, manufacturing, and healthcare.
   • Category III AIFs have seen increasing interest due to the use of alternative strategies, including long-short funds, market-neutral strategies, and quant-based trading in public markets.
6. Assets Under Management (AUM):
   • The AUM of AIFs has witnessed a rapid increase. As of March 2023, AUM across all categories crossed INR 7 lakh crore (approximately USD 85 billion).
   • Category II AIFs lead with the highest AUM, primarily due to the participation of private equity funds and debt funds, making up the bulk of investments.
   • Category III AIFs have also seen a surge in AUM due to increased participation from high-net-worth individuals (HNIs), family offices, and institutional investors looking for diverse investment strategies.
7. Investor Base:
   • AIFs in India primarily attract investments from HNIs, institutional investors, and family offices. AIFs are also being increasingly seen as an attractive investment option by domestic and international investors looking for exposure to alternative asset classes.
   • SEBI’s guidelines mandate a minimum investment of INR 1 crore for AIF investors (around USD 120,000), positioning these funds for wealthy individuals and institutions.

Regulatory Developments and Changes

1. Regulatory Oversight: SEBI continues to fine-tune its regulatory framework for AIFs. Recent changes include:
   • Tightened disclosure requirements for AIFs, particularly with respect to the structure, management fees, and investment strategies.
   • Enhanced guidelines for leverage limits in Category III AIFs, ensuring risk is managed effectively while allowing funds the flexibility to employ their strategies.
2. Taxation:
   • AIFs in Category I and Category II are granted pass-through status for taxation purposes, meaning income from these funds is taxed in the hands of investors and not the fund itself.
   • Category III AIFs, on the other hand, are taxed at the fund level, with gains being taxed based on the nature of income (e.g., capital gains or business income).
3. Foreign Investment:
   • SEBI has allowed Foreign Portfolio Investors (FPIs) to invest in AIFs, making them an attractive option for international investors looking to diversify into Indian markets.
   • Category III AIFs have also become an attractive vehicle for foreign investors seeking exposure to Indian equity and derivatives markets.
4. Investor Protection:
   • SEBI has introduced measures to protect investors in AIFs, including enhanced transparency on fund management practices, valuation norms, and disclosure requirements.

Key Trends and Outlook

1. Growth in Private Equity and Venture Capital:
   • The growing startup ecosystem in India, along with the increasing demand for venture capital and private equity financing, has bolstered the growth of Category I and II AIFs. These funds are expected to continue attracting significant capital due to the opportunities in India’s booming tech and infrastructure sectors.
2. Rise in Hedge Fund Activity:
   • The increasing interest in hedge funds and quantitative strategies has driven the growth of Category III AIFs. With the continued development of financial markets and new technologies, this category is poised for further expansion.
3. Focus on Sustainable and Impact Investing:
   • Investors are increasingly focusing on environmental, social, and governance (ESG)-aligned investments, leading to a rise in Category I AIFs that focus on impact investing, green infrastructure, and social ventures.
4. GIFT City Opportunities:
   • SEBI’s efforts to promote GIFT City as an International Financial Services Centre (IFSC) are encouraging the setup of AIFs within this jurisdiction, providing tax benefits and regulatory advantages, especially for international investments.

AIFs have become an integral part of India’s alternative investment landscape, catering to the diverse needs of sophisticated investors. With continued regulatory support, increasing capital flows, and the expanding investor base, AIFs are likely to play an even more prominent role in India’s financial markets. The growth trajectory of AIF registrations and assets under management signals a maturing market, with ample opportunities for both domestic and international investors.

The below document provides perspective on registration of Cat I, Cat II & Cat III AIFs with SEBI.