Thread by @FincademyIn

What are Alternative Investment Funds?
And How are they different from Mutual Funds?

A thread 🧵👇

1/ Alternative Investment Fund collects money from Investors and pools it together. They then use this money to invest in unconventional avenues like hedge funds, private equity and venture capital, unlike common avenues of investing like equity and debt.

2/ AIFs are like a buffet dinner, where the fund can decide from various options where it can invest in. They can diversify their holdings across hedge funds, private equity and infrastructure funds. There are fewer restrictions on AIFs as compared to Mutual Funds.

3/ Mutual Funds differ from AIFs in this very nature. MFs are not permitted to invest wherever they want. They cannot take naked derivative positions, they cannot take a short position (so, no benefit when the market falls) nor can they invest in a start-up.

4/ Fun Fact - Mutual Funds are allowed to use derivative instruments, but they can do so only for the purpose of hedging their existing positions, they cannot take a speculative position in a derivative instrument.

5/ Because AIFs invest in instruments like hedge funds and venture capital which are inherently riskier, the regulators do not allow retail investors to invest in these funds. Regulators permit only HNIs to invest in these funds who have a bigger risk appetite.

To know more about the difference between MF and AIF, following is the chart of difference between them :-

6/ SEBI has categorized investment avenues for AIFs in 3 categories :

Category 1 : Funds that invest in start-ups, new businesses that have a potential for high growth and can benefit society as a whole.

7/ AIFs looking to invest in this category can do so through venture capital & angel funds which provide capital to potential high growth startups. They can also invest in Infrastructure funds, who provide capital for the necessary construction of roads, dams, etc in the country.

8/ Category 2 : This category is for the AIFs which are looking to invest in equity and debt instruments of companies. They can do so through private equity, who invest in unlisted companies looking for growth capital.

9/ They can also invest in debt funds, who take advantage of special opportunities and invest in distressed companies in expectation of the company turning around and earning a supernormal return.

10/ Category 3 : This category is for AIFs looking at generating a quick buck through short term trading. They can do so by investing in Hedge Funds. Hedge Funds are free to use any market instrument and can take both long and short positions.

11/ Because of this flexibility, hedge funds can take the benefit of both uptrend and downtrend. They also use different trading strategies to generate higher returns compared to the markets.

12/ Another way to invest in this category is through PIPE: Private Investment in Public Fund. PIPE can do so through private placement or QIP. Fund gets an equity stake and the company gets the capital it needed through this transaction.

To know more about these categories, following is the chart of difference between them :-

13/ Who should invest in AIFs?
People looking to diversify their holdings across various avenues or those who want to generate higher returns by taking on more risk can invest in AIF.

14/ So, anyone with the above objective can invest in AIFs?
NO, AIFs are open for HNIs only. All the categories of AIFs in India (except angel fund) require a minimum investment of Rs.1 crore. For the angel fund, the amount is Rs. 25 lakh.

15/ Are the funds open-ended or close-ended?
Most AIFs are close-ended and have a minimum lock-in period of 3 years. They invest in illiquid avenues and hence need time to generate a return and take an exit from their current investments.

16/ Why are AIFs considered risky?
AIFs invest in avenues like Hedge Fund and Venture Capital. For example, Hedge Funds extensively use leverage and one bad day can cause massive losses which makes it a very risky proposition.

17/ Similarly, Venture Capital and Angel Funds invest in start-ups whose success rate is quite low. They burn a lot of capital and hence are in need of constant capital infusion. During bad times, if they are not able to raise funds, they might have to shut their shop.

18/ In India, Alternative Investment Fund is regulated by SEBI. Currently, there were around 703 registered AIFs as of October 2020 with a total AUM crossing ₹1.65 lakh crores. The AIF industry is expected to see humongous growth in the coming years.

BY :- @sneh_kagrana