AIFs pool capital from eligible investors and deploy it across alternative assets such as private equity, venture capital, real estate, infrastructure, private credit, and other unlisted investments. The structure offers fund managers flexibility in strategy design but also involves higher risk, lower liquidity, and longer holding periods compared with conventional instruments.
Classification of AIFs under SEBI Regulations
SEBI classifies AIFs into three categories according to investment focus, use of leverage, and developmental orientation.
Category I AIFs — Development-Oriented Funds
Funds investing in sectors considered socially or economically desirable, often with policy support or incentives.
Sub-categories include:
- Venture Capital Funds (VCFs): Finance early- and growth-stage start-ups. - Angel Funds: Invest in seed-stage ventures. (Under the September 2025 amendment, Angel Funds may raise capital only from accredited investors; the sponsor/manager must maintain at least 0.5 % or ₹50,000 per investment, whichever is higher.) - SME Funds: Support small and medium enterprises. - Infrastructure Funds: Finance projects across transport, energy, and logistics. - Social Impact Funds (SIFs): Invest in enterprises generating measurable social outcomes. (The term “Social Venture Fund” has been replaced with SIF.)
Category I AIFs are close-ended with a minimum three-year tenure.
Category II AIFs — Private Equity and Credit Strategies
Funds that do not use leverage except for temporary borrowings—≤ 10 % of investable funds, for ≤ 30 days, on ≤ four occasions per year—to meet short-term operational needs.
Typical strategies include:
- Private Equity Funds: Invest in unlisted or pre-IPO companies. - Debt / Credit Funds: Provide structured debt or mezzanine financing. (May 2025 amendment: Category II AIFs may also invest in listed debt securities rated ‘A’ or below, subject to disclosure in the placement memorandum.)
- PIPE Funds: Acquire stakes in listed companies via private placements. - Fund of Funds (FoF): Invest in other AIFs (subject to restrictions—FoFs cannot invest in another FoF to prevent multilayering).
Category II AIFs are close-ended with a minimum three-year tenure.
Category III AIFs — Market-Linked and Complex Strategies
Funds employing leverage, derivatives, and sophisticated trading strategies to pursue absolute-return or long–short approaches. They may be open-ended or close-ended.
Examples:
- Hedge Funds: Multi-asset or event-driven trading strategies. - Long–Short Funds / Quant Funds: Take both long and short positions to exploit market inefficiencies. - Leverage limit: aggregate exposure not to exceed 2 × NAV (after permitted hedging offsets).
Eligibility and Investment Criteria
Minimum investment: ₹1 crore per investor; ₹25 lakh for employees/directors of the AIF or its manager.
Maximum investors: 1,000 per scheme (49 for Angel Funds).
Eligible investors: Resident Indians, NRIs, and foreign investors permitted under FEMA.
Minimum corpus: ₹20 crore per scheme (₹10 crore for Angel Funds).
Legal structures: AIFs may be established as a trust, limited liability partnership (LLP), company, or body corporate; most are registered as trusts.
Key SEBI Safeguards and Operational Controls
1. Due Diligence and Investment Restrictions
Fund managers must conduct due diligence on both investors and investee companies, ensure compliance with KYC/AML norms, and prevent the use of AIF proceeds for evergreening or related-party lending.
2. Investor Rights and Parity
SEBI requires pari-passu profit and loss sharing among investors in the same class of units. Side-letters or differential rights are permitted only where non-economic (e.g., information rights) or expressly approved by SEBI. (Amendment Nov 2024 / 2025 added Regulation 20(21) restricting differential rights except for Angel Funds.)
3. Leverage and Encumbrance Controls
Cat I & II: No leverage beyond temporary borrowings.
Cat III: Leverage allowed within the 2× NAV ceiling.
Encumbrance of investee securities by Cat I & II AIFs is permitted only under conditions set out in SEBI’s April 2024 circular.
4. Reporting and Disclosure
Placement Memorandum (PPM): Detailed disclosure of investment policy, risk, valuation, and fee structure; standardised template mandated by SEBI.
Performance and risk reports: Filed periodically with SEBI and shared with investors.
Valuation: At least semi-annually by an independent valuer; may be annual with consent of 75 % of investors by value; more frequent valuation is permitted.
Audits: Annual financial audit and compliance certification mandatory.
5. Procedural Efficiencies and Digital Reforms
Dematerialisation: All new AIF investments to be held in demat form from July 1, 2025, enhancing transparency.
Direct PPM updates: Since April 29, 2024, certain PPM modifications may be filed directly with SEBI, without merchant banker intermediation.
Co-Investment Framework (2025): Allows managers to set up Co-Investment Vehicles (CIVs) for investors to participate alongside the main fund in specific unlisted deals.
Master Circular: SEBI’s Master Circular for AIFs dated May 7, 2024 consolidates all operative circulars for simplified compliance.
Performance Fee and Hurdle Rate
SEBI permits AIFs to charge performance fees (also known as carried interest) based on the returns generated for investors. These fees are typically charged only after a pre-agreed “hurdle rate” is achieved—a minimum return the fund must deliver before the fund manager shares in the profits.
• The hurdle rate is typically disclosed in the Private Placement Memorandum (PPM).
• Performance fees must be fully disclosed and consistently applied across investors to ensure fairness.
• SEBI prohibits differential treatment unless explicitly allowed (e.g., government-backed entities).
Taxation of AIFs – Category-Wise Overview
SEBI does not directly govern tax treatment, but taxation of AIFs depends on the fund category and is guided by the Income Tax Act:
| Category | Tax Treatment |
| Category I & II | Pass-through taxation – income (except business income) is taxed directly in the hands of investors based on their individual tax slabs. |
| Category III | Taxed at fund level – business income is taxed at the maximum marginal rate (MMR) of 42.744%. Capital gains, however, may still be passed to investors depending on the structure. |
Valuation Frequency Requirements
To ensure transparency and fair reporting, SEBI requires AIFs to conduct independent valuation of portfolio assets at defined intervals:
• At a minimum, valuation must be conducted once every six months.
• Some AIFs may opt for quarterly or monthly valuations depending on their asset class and investor requirements.
• Valuations must be carried out by a SEBI-registered independent valuer.
Summary
SEBI’s regulatory regime for AIFs balances flexibility for fund managers with robust investor protection. The recent introduction of dematerialisation, co-investment structures, Angel Fund reforms, and standardised disclosure templates demonstrates SEBI’s continued focus on transparency and governance in India’s alternative-asset ecosystem.
Disclaimer
This content is for educational purposes only and should not be construed as investment advice or solicitation. AIFs are regulated by SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012 and are suitable only for investors who understand and accept higher risk, illiquidity, and capital loss potential. Past performance is not indicative of future results.
References
SEBI (Alternative Investment Funds) Regulations, 2012 (as amended up to May 23, 2025) — Notification No. LAD-NRO/GN/2012-13/04/11262
Master Circular for Alternative Investment Funds (AIFs) — Circular No. SEBI/HO/AFD-1/P/CIR/2024/48 (May 7, 2024)
Framework for Co-Investment by Category I and II AIFs — Circular No. SEBI/HO/AFD/SEC-1/P/CIR/2025/85 (May 23, 2025)
Amendment to Investment Norms for Category II AIFs — Circular No. SEBI/HO/AFD/SEC-3/P/CIR/2025/64 (May 7, 2025)
Standardisation of PPM Audit Reports for AIFs — Circular No. SEBI/HO/AFD/SEC-1/P/CIR/2024/22 (April 18, 2024)
Dematerialisation of Units of AIFs — Circular No. SEBI/HO/AFD/SEC-1/P/CIR/2024/91 (June 25, 2024)
Extension of Timeline for Dematerialised AIF Investments — Circular No. SEBI/HO/AFD/POD-1/P/CIR/2025/17 (February 14, 2025)
Amendment Regulating Differential Rights under Regulation 20(21) — SEBI (AIF) Fifth Amendment (November 15, 2024)
Valuation Framework for Alternative Investment Funds (AIFs) — Circular No. SEBI/HO/AFD/SEC-3/P/CIR/2024/156 (September 19, 2024)
Relaxation in Timeline for Reporting Differential Rights Issued by AIFs — Circular No. SEBI/HO/AFD/AFD-POD-1/P/CIR/2025/29 (March 3, 2025)