Alternative Investment Funds (AIFs) in India have crossed ~Rs 5 trillion in terms of funds raised, while the investment commitments have surpassed ~Rs 12 trillion for the first time as of September 2024. However, Alternatives AUM is just ~5% of its GDP compared to US and UK at ~50% and ~10%, clearly signifying the growth potential of the AIFs in India. In comparison to Mutual Fund’s (MF) AUM of Rs ~67
trillion, AIFs clearly have a lot of runways to cover. ‘Alternative investments’ is yet to get into mainstream due to various myths surrounding this space. Much of it is built on anecdotal evidence, oversimplification or at times misrepresentation of facts. Let’s demystify some myths about alternative investing: –

1. 1. Alternatives are only for the wealthy or institutional investors: While it’s true that historically, access to alternative investments like private equity or venture capital funds was limited, the landscape has changed dramatically. Today, there are numerous options available for individual investors to invest in AIFs where the investment drawdown is staggered over 2-3 years or directly in startups. The growing wealth in India, increase in number of millionaires, innovative business ideas, coupled with the need for diversification and better risk adjusted returns is driving the gradual growth of AIFs with professional management; further supported by enabling regulatory reforms and transparency.
2. Alternatives are inherently risky: Every investment, when viewed in isolation, is risky. While it’s essential to understand that all investments carry risk, many alternative assets can provide stability and protection against market volatility or inflation. For instance, absolute return strategies that are market neutral and non-directional, target to provide better returns irrespective of upward or downward trends in the capital markets. AIFs that have exposure to derivatives strategies or real estate often have low correlation with traditional stocks and bonds, making them valuable hedges during turbulent times.
3. Investors cannot access their money if they invest in Alternatives: The access to liquidity for alternatives investments depends on the Fund’s strategy. Like other instruments, Category 3 AIFs do provide access to liquidity on a fortnightly/monthly/quarterly basis. Most of the AIFs that invest in capital appreciation or regular cash flows have a fund tenure of 3-7 years (e.g. private equity/credit and real estate) where subject to the investment manager’s approval, transfers are allowed. Recent regulatory changes where dematerialization of AIF units is made mandatory have opened avenues for taking leverage against the AIF investments.
4. Alternative investment lacks transparency: Frequent investor calls by the fund manager, monthly newsletter, regular net asset value statements, portfolio disclosure and annual audited accounts of the AIFs ensure adequate transparency about the investment strategy, portfolio details as well as associated risk.
5. Fees charged based on AUM, irrespective of performance: Despite most traditional Asset management company charging fixed fees as a % of AUM, many AIFs have opted for investing its own proprietary capital and performance linked fees, where fees are charged only in case of outperformance, to ensure adequate ‘skin in the game’ and always being on toes.
6. Investing in one AIF shall diversify portfolio: An investor can categorize AIFs that run liquid strategies, illiquid strategies and beta plus strategies and diversify its investments across these three strategies to meet its objectives with respect to capital appreciation, regular cash flows, easy liquidity, and favorable risk-return matrix etc.
7. Higher tax rates on income earned from AIFs: Like other instruments, most of the income earned by AIF is taxable in the hands of the investor, as Category 1 and 2 AIFs are considered as pass through vehicles. Capital gains or any income other than business income is taxed directly in the hands of the investor, as per the tax status of the investor.

In case of category 3 AIF, the tax incidence is at the fund level at maximum marginal rates, consequently the returns are not taxable in the hands of investor.

Since the introduction of AIF guidelines in 2013, SEBI has stepped up its monitoring and implemented governance measures such as independent audit, valuation norms, benchmarking, mandatory dematerialization, appointment of custodian, liquidation norms and regular compliance filings to ensure adequate investor trust and industry development. By dispelling these basic myths, AIFs open a world of opportunities that are worth exploring for asset diversification and wealth accumulation.

Embracing this asset class could be a game-changer for your investment strategy—one worth considering as you navigate your financial future.