In traditional investment – stocks and bonds are often at the heart of attention. The concept of ‘alternative investments’ is about choosing avenues to invest in those asset classes beyond stocks and bonds.
Over the years, pooled funds like Alternative Investment Funds (AIFs) and mutual funds have become very popular with investors as these investment vehicles provide portfolio diversification through professional management.
As of March 31, 2024 – AIFs experienced the highest-ever investment commitments of more than ₹11 trillion, while funds raised exceeded ₹4 trillion.
Source: SEBI
Mutual funds assets under management (AUM) increased by over twofold over the last five years – from ₹24.25 trillion as of June 30 2019, to ₹61.16 trillion as of June 30 2024.
However, which choice will you choose for alternative investment funds vs mutual funds?
Understanding Mutual Funds
Mutual funds are investment options where money from many investors is pooled to buy a range of traditional assets, including:
- Stocks
- Gold
- Bonds
- Money market instruments
Professional fund managers take charge of these investment pools, researching and selecting assets that align with the investors’ goals.
Five types of mutual fund categories are:
- Equity schemes
- Debt schemes
- Hybrid schemes
- Solution-oriented schemes – For Retirement and Children
- Other schemes – Index funds & ETFs and Fund of Funds
What is an Alternative Investment Fund?
Alternative investment funds are privately pooled investment vehicles which collect funds from investors – whether Indians or foreigners – for investing in accordance with a defined investment policy for the benefit of its inventors.
AIFs invest in:
- Hedge funds
- Private Equity
- Commodities
- Venture capital
- Real estate and
- Derivatives
Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 groups AIFs into three major categories.
Category I AIFs: This includes:
- Venture capital funds (including angel funds),
- Infrastructure funds
- Small and medium-sized enterprises funds and
- Social venture funds.
This category focuses on encouraging entrepreneurship and development purposes.
Category II AIFs: This category includes:
- Real estate funds
- Private equity funds (PE) and
- Distressed assets funds.
Category III AIFs: In this category, we have:
- Hedge funds, among others, and
- Private Investment in Public Equity Funds.
Alternative Investment Funds vs Mutual Funds
Here’s a quick difference between alternative investment fund and mutual fund:
1. Investment Required
AIFs: High – a minimum investment of ₹1 crore (India) is required.
Mutual Funds: Low – Investments can start as low as ₹100 for Systematic Investment Plans (SIPs).
2. Regulation
AIFs: They are regulated by SEBI under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012.
Mutual Funds: These are also regulated by SEBI under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, but have more stringent regulations compared to AIFs.
3. Asset Type
AIFs: They invest in a wider range of assets and conventional asset classes like bonds and stocks. Including:
- Real estate
- Hedge funds
- Venture capital
- Private equity and
- Derivatives
Mutual Funds: They invest in more conventional asset classes like:
- Stocks
- Gold
- Bonds
- Money market instruments.
4. Liquidity
AIFs: AIFs have a commitment period. This is the period during which investors are generally not allowed to redeem their investments. The commitment period is essential for the fund manager to deploy the capital effectively, execute the investment strategy, and achieve the fund’s objectives.
The commitment period makes this investment option less liquid than mutual funds. For instance, Category I and II AIFs have a lock-in period of 3 years. Category III AIFs can be both open-ended and close-ended.
If investors redeem before the commitment period, a penalty might be imposed.
Note: Please read the Private Placement Memorandum to know in detail about the category of the scheme, lock-in periods and other scheme details.
Mutual Funds: Debt mutual funds are generally more liquid compared to equity mutual funds. For example, ELSS, or Equity Linked Saving Schemes, offer tax benefits, but they also have a lock-in period of 3 years.
5. Risk
AIFs: They carry higher risk due to complex strategies and less-traded assets.
Mutual Funds: The risk can vary but is generally lower than AIFs due to diversification and focus on traditional assets.
However, investors should consult their financial advisors before investing.
6. Volatility
AIFs: They are often thought to be more prone to volatility because they practise complex investment approaches and possess non-standard assets.
Mutual Funds: Volatility can vary depending on the type of mutual fund and other macro and micro economic factors. Stock-based funds are typically more volatile than bond funds.
7. Taxation
AIFs: Taxation depends on which category of AIF you own and the nature of your income.
| Type of Income | Category I | Category II | Category III |
| Tax Liability | Investor | Investor | AIF |
| Long-Term Capital Gain (Listed Shares) | 12.5% | 12.5% | |
| Long-Term Capital Gain (Unlisted and Others) | 12.5% | ||
| Short-Term Capital Gain (Listed Shares) | 20% | 20% | |
| Short-Term Capital Gain (Unlisted and Others) | Slab Rate | ||
| Dividend Income | Maximum Marginal Rate | 30% | |
| Business Income | 30% | ||
Mutual Funds: Taxation depends on the category of mutual fund and holding period. The taxation rules for mutual funds have changed in the Union Budget 2024.
| Before Budget 2024 | After Budget 2024 | |||||
| Holding Period for LTCG | Short Term | Long Term | Holding Period for LTCG | Short Term | Long Term | |
| Equity Funds | More than 12 months | 15% | 10% | More than 12 months | 20% | 12.5% |
| Debt Funds | More than 36 months | Slab rate | Slab rate | More than 24 months | Slab rate | Slab rate |
| Equity FoFs/Overseas FOF/Gold Mutual Funds | More than 36 months | Slab rate | Slab rate | More than 24 months | Slab rate | 12.5% |
Note: Do note that LTCG exemption for equity-oriented funds has increased from ₹1 lakh to ₹1.25 lakhs.
What Should You Choose?
The choice between AIFs and mutual funds depends on your risk tolerance, the amount to be invested and investment goals.
Choose AIFs if:
- If you can invest significant capital.
- If you can take high levels of risks and volatility.
- You want to invest in funds beyond stocks, bonds, and mutual funds – These include portfolios like real estate or hedge funds.
- You are ready for a lock-in period (applicable to Category I, Category II and Category III AIFs, if they are close-ended).
Choose mutual funds if:
- You want to take less risk compared to AIFs.
- If you want to put your money into gold, stocks and bonds, then think about investing in mutual funds.
- You want a lower lock-in period. Lock-in periods do not apply to most mutual funds except ELSS; hence, they are flexible compared to AIFs.
Final Thoughts
The universe of investment choices has expanded greatly. Although mutual funds remain attractive to some investors, alternative investment funds can be an option for many investors who would like to invest in comparatively riskier assets for potentially higher returns.
Looking at your own situation will help you determine what is “right.” Think about what you want to achieve financially, how much risk you can take on or possibly when you want to cash out an investment before deciding whether AIFs or mutual funds are more suitable.
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Frequently Asked Questions
Is AIF better than a mutual fund?
Individual investors decide whether to invest in AIFs or mutual funds based on their investment objectives and risk tolerance. If you can afford to invest a huge sum, desire higher potential profits along with higher risk and volatility, and don’t want to limit yourself to stocks and bonds, then AIFs would be preferable.
Nonetheless, low-risk appetite investors might consider investing in different categories of mutual funds.
What is the difference between mutual funds and alternative funds?
The key distinction between Alternative Investment Funds (AIFs) and Mutual Funds (MFs) lies in their accessibility and investment thresholds. AIFs are reserved for accredited investors and come with higher minimum investment requirements.
On the other hand, mutual funds are designed to be more accessible to the general public, with lower entry barriers making them available to a broader audience.
What are the alternative investment funds?
Alternative investment funds are privately pooled investment vehicles which collect funds from investors – whether Indians or foreigners – for investing in accordance with a defined investment policy for the benefit of its inventors.
AIFs invest in:
- Hedge funds
- Private Equity
- Venture capital
- Real estate, etc.
Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 groups AIFs into three major categories: Category I, II and III.
Is AIF risky?
Yes, alternative investment funds carry more risk compared to mutual funds. AIFs target unique assets like startups, real estate, or private debt. While these offer the potential for high returns, they are not traded, making them potentially volatile and harder to sell quickly (lower liquidity). This means your money might be tied up for longer and experiencing value fluctuations.