Alternative investments are a class of assets that are distinct from traditional forms of investments, such as stocks, bonds, and cash. These investments are gaining popularity because of their potential to generate substantial returns and their ability to offer portfolio diversification. Investors seeking high returns investments may find alternative investments appealing. Additionally, secure investment options such as alternative investment funds (AIFs) are gaining traction as they offer investors the ability to overcome the restrictions associated with traditional investing. This blog explores the state of alternative investments in India and how regulatory agencies govern them.
Regulation and Classification of Alternative Investment Funds (AIFs)
The Securities and Exchange Board of India (SEBI) is the principal body regulating alternative investment funds in India. SEBI oversees Alternative Investment Funds (AIFs) in India via the SEBI (Alternative Investment Funds) Regulations, 2012. These regulations outline the framework for AIFs’ operations and management in India, covering areas such as registration, investment objectives, risk management, disclosure requirements, and reporting.
AIFs are classified by SEBI into three distinct categories based on various factors. These categories are:
1. Category-I AIFs
AIFs falling under this category have a beneficial influence on the economy and can avail of specific incentives and concessions provided by the government. These AIFs are as follows:
- Venture Capital Funds: SEBI governs Venture Capital Funds (VCFs) via the SEBI (Venture Capital Funds) Regulations, 1996. VCFs are a type of AIF that invests in start-ups and emerging companies that exhibit high growth potential. The regulations outline the guidelines for registration, investment criteria, valuation, risk management, and disclosure norms. VCFs must invest at least 66.67% of their funds in unlisted equity shares of start-ups or equity-linked securities, or other unlisted firms, as per the regulations.
- SME Funds: SEBI regulates SME funds in India by issuing IPO guidelines and mandating SMEs to list on the SME Exchange. To supervise SME funds, SEBI mandates that they should be managed by competent fund managers and adhere to investment guidelines, including a minimum investment in SMEs and a cap on the exposure to any one SME. Investment strategy, portfolio, and performance should all be disclosed, and SEBI conducts regular inspections and audits. These measures aim to safeguard investment interests and promote the growth of the SME sector in India.
- Social Venture Funds: SEBI mandates that AIFs, including social venture funds, register themselves and comply with the applicable rules for AIFs. The guidelines and regulations prescribed by SEBI for AIFs also extend to social venture funds, covering several areas such as eligibility requirements for fund managers and investors, investment standards, disclosure norms, and compliance criteria. Furthermore, SEBI directs social venture funds to allocate a significant proportion of their corpus towards social welfare initiatives. The primary objective of these regulations and guidelines is to facilitate the growth of social entrepreneurship in India while ensuring the transparency and accountability of social venture funds.
- Infrastructure Funds: In India, infrastructure funds are regulated by the SEBI (Infrastructure Investment Trusts) Regulations, 2014, which oversee the establishment, registration, and operation of infrastructure investment trusts (InvITs) that invest in infrastructure projects. Investors seeking passive income options may find InvITs to be an attractive investment option as they provide regular income streams. The primary goal of these regulations is to promote transparency and safeguard the interests of investors. SEBI regularly reviews and revises these regulations to facilitate the ongoing development and expansion of the infrastructure sector.
2. Category-II AIFs
AIF Category II refers to those alternative investment funds that are not classified as either Category I or III and adhere to SEBI’s Alternative Investment Funds Regulations of 2012, by refraining from utilizing leverage, except for day-to-day operational requirements. Different types of funds, including private equity, real estate, distressed assets, etc., fall under Category II AIFs and are registered as such. Let’s discuss these funds in detail.
- Real Estate Funds: Real estate funds are governed by SEBI through its 2014 SEBI (Real Estate Investment Trusts) Regulations. REITs are investment vehicles that pool funds for real estate assets generating income. SEBI’s regulations aim to ensure transparency and investor protection, including investment restrictions such as a minimum of 80% of assets in income-generating completed properties. REITs must be listed on stock exchanges for liquidity, and SEBI regularly evaluates and revises the legislative and regulatory framework to foster the growth of the real estate sector.
- Private Equity Funds: SEBI supervises private equity funds as Category II AIFs under the SEBI (Alternative Investment Funds) Regulations, 2012. These funds are independent pooled investment entities that invest in assets like securities, debt, and real estate. SEBI regulations require disclosure of investment strategy, fees, and performance, along with ensuring transparency and investor protection. The regulations also mandate leverage caps and asset safeguards through custodial custody.
- Distressed Asset Funds: SEBI regulates distressed asset funds as Category II AIFs under the SEBI (Alternative Investment Funds) Regulations, 2012. These funds invest in distressed assets like non-performing loans, distressed debt, and stressed assets. SEBI ensures transparency and investor protection by mandating investment strategy, fees, and performance disclosure.
3. Category-III AIFs
Category III AIFs comprise various types of funds, such as hedge funds, PIPE funds, and others that employ diverse or complex trading strategies and may use leverage, including investing in listed or unlisted derivatives.
- Hedge Funds: SEBI governs hedge funds in India as Category III Alternative Investment Funds (AIFs) under the SEBI (Alternative Investment Funds) Regulations, 2012. Hedge funds use intricate trading strategies and may invest in listed or unlisted derivatives and use leverage. SEBI continuously reviews and monitors the regulatory framework for hedge funds to promote the growth and development of the alternative investment industry in India.
- PIPE Funds: SEBI governs PIPE funds as Category III Alternative Investment Funds (AIFs) in India, according to the SEBI (Alternative Investment Funds) Regulations, 2012. PIPE funds are privately pooled investment entities that purchase a significant share in publicly listed companies’ equity.
Conclusion
As investors in India seek to diversify their portfolios and achieve good returns, alternative investments are becoming increasingly popular. The Securities and Exchange Board of India (SEBI) regulates alternative investment funds (AIFs) in India through the SEBI (Alternative Investment Funds) Regulations, 2012. SEBI’s regulations cover reporting, disclosure requirements, risk management, and registration for AIFs, which are divided into three categories. These categories include distressed asset funds, infrastructure funds, real estate funds, private equity funds, SME funds, social venture funds, venture capital funds, and real estate funds. SEBI regularly assesses and revises its regulations to promote the alternative investment market’s growth and protect investors’ interests. As India’s economy and infrastructure continue to develop, the alternative investment market is expected to expand, providing investors with new opportunities.
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