Investments in real estate, private equity, land, venture capital, intellectual property, and equity long-short strategies are all alternative investments. An investment not made in bonds, stocks, and cash may be considered an alternative investment.
Across India, there are three categories in which alternative investments may be made.
Investments in SME Funds, Infrastructure Funds, Social Venture Funds, and Venture Capital Funds are classified under Category 1. Funds in Category 1 invest in economically and socially desirable ventures.
Private Equity Funds and Debt Funds fall are classified under category 2 Alternative Investment Funds (AIFs). An alternative investment that doesn't fall in Category 1 or Category 3 may be clubbed in Category 2.
In Category 3 are funds that employ complex and diverse investment strategies that take on higher levels of risk in an effort to earn higher than average returns.
Funds in the third category may use leverage and invest across different investment products. Hedge Funds fall in Category 3. Today there are over 520 AIFs registered with SEBI.
Category I AIF
- Venture Capital Fund (VCF)
Venture Capital Funds invests in StartUps which have high growth potential but facing investment crunch in the initial phase and need funding to establish or expand their business. Since it is difficult for new businesses and entrepreneurs to raise funding through the capital markets Venture Capital Funds become the most sought after solution for their financing needs.
VCFs pool in money from investors who want to make equity investments in ventures. They invest in multiple startups, depending on their business profiles, assets’ size, and phase of product development. Unlike mutual funds or hedge funds, venture capital funds focus on early-stage investment. Each investor gets a share of the business the VCF has invested in proportional to their respective investment.
High Net Worth Investors (HNIs) who seek high risk-high return investments options prefer to invest in VCFs. After the inclusion of VCFs in AIFs, HNIs from abroad are also able to invest in VCFs and contribute to the growth of the economy.
- Infrastructure Fund(IF)
The fund invests for the development of public assets such as road and rail infrastructure, airports, communication assets etc. Investors who are bullish on the infra development in the coming times can invest in the fund since the infrastructure sector has high barriers to entry and relatively low competition.
Returns from investing in Infrastructure Fund can be a combination of capital growth and dividend income. When an Infrastructure Fund invests in socially desirable/viable projects, the government may also extend tax benefits on such investments.
- Angel Fund
This fund is a type of Venture Capital fund where fund managers pool money from numerous “angel” investors and invest in budding startups for their development. As and when the new businesses become lucrative, investors get the dividends.
In the case of Angel Funds, units are issued to the angel investors. An “angel investor” refers to an individual who wants to invest in an angel fund and brings in business management experience, thus guiding the startup in the right direction. These investors typically invest in firms which are generally not funded by established venture capital funds because of their growth uncertainty.
- Social Venture Fund
Socially responsible investing has led to the emergence of Social Venture Fund (SVF) that typically invests in companies that have a strong social conscience and aim to bring a real change in the society.
These companies focus on making profits and solve environmental as well as social issues simultaneously. Even though it is a kind of philanthropic investment, one can still expect returns because the firms would still make profits.
Social Venture Fund generally invests in projects based out of developing countries as they have great potential for growth as well as social change. Such investments also bring the best managerial practices, technology and vast experience on the table which makes it a win-win deal for all stakeholders including investors, enterprises and society.
Category II AIF
- Private Equity (PE) Fund
PE funds basically invest in unlisted private companies and take a share of their ownership. Since unlisted private companies can not tap capital through the issuance of equity or debt instrument, they look out for PE funds.
Further, these companies present its investors a diversified portfolio of equities which essentially, lowers the risk to the investor. A PE fund typically has a fixed investment horizon ranging from 4 to 7 years. After 7 years, the firm expects that it would be able to exit the investment with a good amount of profit.
- Debt Fund
This fund primarily invests in debt instruments of listed as well as unlisted companies.
Companies that have low credit score generally release high yield debt securities accompanies with high risk. So companies with high growth potential, good corporate practices but facing capital crunch can be a good investment option for debt fund investors.
As per the SEBI regulations, the amount invested in Debt Fund cannot be utilised for the purpose of giving loans, as Alternative Investment Fund is a privately pooled investment vehicle.
- Fund of Funds
As the name suggests, this fund is a combination of various Alternative Investment Funds. The investment strategy of the fund is to invest in a portfolio of other AIFs rather than making its own portfolio or deciding what specific sector to invest in. However, it should be kept in mind that Fund of Funds under AIFs cannot issue units of fund publicly, unlike Fund of Funds under Mutual Funds.
Category III AIF
- Hedge Fund
A hedge fund pools capital from institutional and accredited investors and invests in domestic as well as international markets to generate high returns. They take up leverage to a great extent and have aggressive management of their investment portfolio. Hedge funds are relatively less regulated as compared to its counterparts such as mutual funds and other investment vehicles.
However, they are expensive relative to other financial investment instruments. Hedge Funds generally charge 2% as the asset management fee and take up 20% of the profits earned as a fee.
- Private Investment in Public Equity Fund (PIPE)
It is a privately managed pool of privately sourced funds earmarked for public equity investments. Private investment in public equity refers to buying shares of publicly traded stock at a discounted price. This enables the investor to purchase a stake in the company, while the company selling the stake receives capital infusion to grow its business.