What are AIFs?
AIFs are unique investment vehicles that invest in alternative asset classes, such as derivatives, commodities, real estate, hedge funds, private equity, and venture capital, through private pooling. Compared to other investing alternatives, such as equities, mutual funds, and fixed deposits, they are very different. Alternative investment funds have the ability to buy equity shares of unlisted businesses. Nonetheless, alternative funds could employ complex trading strategies to profit in a variety of market conditions.
These alternative strategy funds are supervised by the Securities and Exchange Board of India (SEBI). The SEBI (Alternative Investment Funds) Regulations of 2012 allow AIFs to be set up as companies, limited liability partnerships, trusts, or corporations. A large number of alternative funds are listed as trusts with SEBI.
Alternative asset funds are classified into three categories:
1. Category I: These funds make investments in early-stage, unlisted companies using loan (venture capital) or equity. Additionally, these alternative asset funds have the ability to engage in infrastructure-based projects or social projects.
2. Category II: Also known as private equity or pre-IPO, these funds make investments in the debt or equity of unlisted companies that are in the middle or late phases of growth.
3. Category III: The funds in this group invest in publicly listed companies’ shares. For any period of time, these alternative strategy funds may be long-only or long-and-short.
How to Invest in Alternative Investment Funds
Exchange-traded funds (ETFs), hedge funds, and mutual funds are examples of alternative funds that invest in non-traditional assets such commodities, real estate, and alcoholic drinks.
Before investing, it is essential to understand the objectives and strategies of alternative funds.
- Investment objective: Depending on the asset management, certain alternative funds could only concentrate on a single asset class. Others who want to reduce risk could invest in several alternative asset types. You may choose the alternative fund that best suits your needs by matching it to your unique investing objectives.
- Investment strategy: Alternative funds might have higher expenses and risks since they require active management. This is because alternative fund managers frequently employ more complex trading and investing strategies. They include the use of derivatives and short sales of stocks, as well as “market neutral,” “absolute return,” and leveraged approaches.
Various Types of Alternative Investment Funds
It is important to keep in mind that the majority of alternative investment types require certification; retail and non-professional investors may need to fulfil extra requirements in order to be eligible.
The five main categories of alternative investment funds are as follows:
- Private equity fund: A private equity fund pools the capital of professional investors and uses it to buy stakes in both public and private markets and companies, in contrast to private credit, which entails investors lending money to companies rather than owning a piece of them. The fund then actively supports these companies by giving them capital and guidance. The objective is to increase the company’s revenue and accelerate its growth. The private equity fund departs whenever it sells its stake to another company or takes the company to an initial public offering (IPO).
- Hedge fund: Usually, only accredited and institutional clients are served by hedge funds. Hedge funds are actively managed by experienced investors who aim to maximise returns, which are frequently higher than those of the markets. In the more complex hedge fund approach, the investment manager may invest in a range of assets, such as derivatives, fine wine, real estate, and artwork. This investment has a significant level of risk since they often use leverage, or borrowing money.
- Venture Capital Fund: A venture capital fund provides funding to start-ups in exchange for a stake in the company. Although these funds are thought to be quite risky, there is a possibility for significant rewards. Nevertheless, they are frequently only accessible to authorised investors. A venture capitalist is typically committed to the growth of the startup. Individual investors help the organisation reach its goals, monitor its progress, and provide guidance. They often sit on the board of directors and depart the company at the completion of an IPO, merger, or acquisition.
- Real estate funds: These alternative investment vehicles invest in assets offered by REITs (real estate investment trusts) or publicly listed real estate companies. They provide value through the appreciation of the tangible assets and can be managed either actively or passively. Investors can buy real estate fund assets directly from the fund’s founding company or through an online broker. These products are not suitable for investors looking for quick cash gains because they need a long-term commitment.
Real estate funds may be divided into three main categories:
- Real estate mutual funds: These can be closed- or open-ended and often need a substantial initial commitment.
- Exchange-traded funds for real estate: These funds own shares of actual assets and real estate investment trusts.
- Private real estate investment funds: These funds’ alternative investment managers make direct real estate investments.
- Fund of funds: A fund of funds (FOF) is usually an ordinary mutual fund, hedge fund, or private equity fund. Investments in hedge funds or other alternative mutual funds are typically made by FOFs. Therefore, their portfolios consist of other funds rather than investment product assets (traditional investments) like stocks and bonds. Their strategy is on improving portfolio variety, lowering risk, and balancing asset allocation. However, investment in this type of alternative mutual fund is sometimes linked to higher cost ratios.
Why Make an Investment in Alternative Investment Funds?
Investing in alternative investment funds offers the following advantages:
- Higher returns: Alternative funds may yield higher investment returns, despite their higher level of risk.
- Minimal correlation with the stock market: One of the best things about alternative funds is that they hold their value during times of stock market fall, and sometimes even increase it.
- Decreased volatility: Because alternative funds are not as exposed to the entire investment market, they are less volatile.
- Portfolio diversification: Because of the minimal correlation between equities, alternative investments are a great way to diversify your holdings.
- Protect yourself from inflation: Using funds to invest in tangible goods such as gold, wine, real estate, and oil is a great way to guard against inflation and price fluctuations.
Considerations Prior to Making an Alternative Fund Investment
Even though alternative investment funds have numerous benefits, you should be aware of the following factors that influence their performance:
- Greater risk: Only accredited investors and regular investors who fulfil certain requirements can access alternative funds, which are frequently high-risk investments.
- Higher initial investment: Alternative investments are often only accessible to qualified investors due to their high initial investment requirements. For example, investors may have to fulfil certain financial condition requirements, such as having a net worth of $1 million or earning $200,000 a year.
- Higher expenses: Due to their more complex structure and active investment manager involvement, alternative investment funds frequently have higher charges (the expense ratio can easily be above 1.5%).
- Legal structure uncertainty: Alternative funds usually have a vague legal structure and ambiguous contents.
- Valuation is difficult: Assessing alternative investment assets is often difficult. This is because, in contrast to traditional stocks, they lack a recognised market price, and their value is determined by the appraiser’s personal opinion.
Low liquidity: Because many alternatives are not traded publicly, they have less liquidity than traditional investing assets. Investors in some private companies and hedge funds are also required to commit for a set amount of time before they can sell their interests.
Share This Post
