Overview of Alternative Investment Funds (AIFs): formula sheet

Key formulas

Definition of AIF

AIF = privately pooled investment vehicle + established or incorporated in India + registered with SEBI under AIF Regulations, 2012

All three parts matter. A fund that is not registered, or is already covered by another SEBI fund regulation, is not an AIF.

Legal forms allowed

Trust | Company | Limited Liability Partnership (LLP) | Body corporate

Know that an AIF can take these forms. Trust is the most common in practice.

Three categories

Category I, Category II, Category III

Category is named in the registration. Study the details in the topic on categories of AIFs.

AIF vs mutual fund: investor base

AIF: private pooling, sophisticated and high net worth investors | Mutual fund: public offer, all investors

Frequent comparison point in MCQs.

AIF vs PMS: ownership

AIF: investor holds units in a pooled fund | PMS: securities held in the client's own name in a separate account

In PMS the portfolio is individually managed. In an AIF the money is pooled.

Category I AIF

Start-ups, early stage, SMEs, social ventures, infrastructure → VC, SME, social venture, infrastructure funds

Invests in sectors seen as socially or economically desirable. Government or regulators may give incentives. Close-ended.

Category II AIF

Residual category → private equity, debt funds, fund of funds

Does not fit I or III. No borrowing except for day-to-day operational needs, within regulatory limits. No specific concessions. Close-ended.

Category III AIF

Diverse or complex trading strategies, may use leverage → hedge funds, PIPE funds

May invest in listed or unlisted derivatives. Can be open-ended or close-ended. No concessions.

Key contrast

Leverage: Cat I and II = no (except day-to-day needs, within limits) | Cat III = yes, permitted

This is the most tested difference between Category II and Category III.

Management fee

Management fee = fee rate × capital base (committed or invested, per PPM)

Charged irrespective of performance.

Hard hurdle carry

Carry = carry % × (profit − hurdle amount), if profit > hurdle

No carry on the hurdle portion itself.

Soft hurdle with full catch-up

If profit > hurdle and the catch-up is full: Carry = carry % × total profit; otherwise nil

This holds for a full catch-up only. With a partial catch-up, carry is less than carry % × total profit. Follow the catch-up terms in the PPM.

Pass-through rule

Cat I and Cat II: pass-through under Section 115UB, tax in investors' hands. Cat III: no pass-through; taxed at fund level, and a trust follows the general trust rules (for example, the maximum marginal rate if beneficiaries' shares are indeterminate)

Section 115UB applies to Cat I and II only. Business income of Cat I/II is taxed at the fund, not in the investor's hands.

Minimum investment

General minimum ₹1 crore per investor

Exceptions apply for employees or directors of the manager; large value funds for accredited investors have a higher minimum, as specified by SEBI.

Quick revision

• An AIF is a privately pooled investment vehicle set up in India and regulated by SEBI under the AIF Regulations, 2012.
• AIFs are for investors who can bear higher risk and lower liquidity; they are not mass-market products.
• Category I funds invest in start-ups, early-stage ventures, SMEs, social ventures or infrastructure, which SEBI or the government views as socially or economically useful.
• Category I sub-types: venture capital, SME, social venture, infrastructure and angel funds.
• Category II funds include private equity and debt funds, and do not take leverage other than to meet day-to-day operational needs, within permitted limits.
• Category III funds, such as hedge funds, use diverse or complex strategies and may use leverage, including through derivatives, within SEBI limits.
• Category I and II AIFs are closed-ended with a minimum tenure of three years. Category III AIFs may be open-ended or closed-ended, and the regulations do not cite a three-year minimum tenure for them. Check the workbook for the detail.
• The usual minimum investment per investor is ₹1 crore, with lower limits for certain investors such as angel fund investors and employees or directors of the AIF or its manager; verify in your workbook edition.
• Under the AIF Regulations, an AIF is set up in India as a trust, company, LLP or other body corporate (a company is itself a body corporate). In practice most AIFs are trusts. Every AIF must be registered with SEBI.
• Fees commonly include a management fee and a performance fee or carry, often linked to a hurdle return; all are disclosed in the placement memorandum.
• Category I and II AIFs have pass-through tax status for income other than business income, which is taxed at the fund. Category III AIFs do not get pass-through status and are taxed at the fund level. Tax rules in this area have changed over time, so check the exact treatment in the current workbook edition.
• Before recommending an AIF, check the client's risk profile, liquidity need, investment horizon and ability to commit a large sum.

Common mistakes

• Treating an AIF as just another type of mutual fund. Fix: Remember that AIFs are privately pooled and regulated by the AIF Regulations, 2012. Mutual funds are regulated separately and are offered to the public.
• Thinking an AIF is open to all retail investors with small amounts. Fix: Link AIFs with sophisticated, higher net worth investors, high minimum commitments and limited liquidity.
• Placing private equity funds in Category I because they invest in unlisted companies. Fix: Venture capital is Category I. Private equity is Category II. Think: VC backs start-ups, PE is the residual group.
• Saying Category II funds can use leverage freely. Fix: Category II may borrow only to meet day-to-day operational needs, within limits. Free use of leverage and derivatives is a Category III feature.
• Saying all AIFs have pass-through taxation. Fix: Link pass-through to Category I and II only; Category III is taxed at fund level.
• Charging carry on the full profit under a hard hurdle. Fix: Under a hard hurdle subtract the hurdle amount first.

Exam tips

• Learn the definition word by word: privately pooled, established in India, registered under the 2012 Regulations. Questions often test one missing element.
• For comparison questions, fix one dimension first, such as investor base or pooling, then compare. This removes trap options quickly.
• Remember that mutual funds and collective investment schemes are outside the AIF definition.
• Do not select options with words like guaranteed or always. AIF returns and risks depend on the strategy.
• X-A has negative marking of 25% of the marks of a question. Skip a question only if you cannot narrow the options to two.
• Memorise one example per category: venture capital for I, private equity for II, hedge fund for III.
• The Category II versus III split is usually tested on leverage and derivatives, so read for those words.
• Watch for 'open-ended': it points to Category III only. Categories I and II are close-ended.