Lock-in Period
The stretch of time after an investor commits money to a Category III AIF during which they cannot redeem — not fixed by SEBI, but 2 years is common practice.
In plain language
You put money into a Category III AIF. Can you ask for it back next month? Usually not.
A lock-in period is the time an investor must wait before they can redeem, or exit, their units. The Manager sets this condition. It is not a number fixed by SEBI. But the workbook says a 2-year lock-in is common across most Category III AIFs in practice.
The lock-in exists for a plain reason. If investors could redeem whenever they liked, the fund would face frequent cash outflows. That could force the manager to sell good investments at a bad time, just to raise cash. A lock-in protects the fund from that.
How it works
Two structures, two different lock-in styles.
- A closed-ended Category III AIF has a minimum tenure of 3 years — the same minimum that applies to closed-ended Category I and Category II AIFs.
- An open-ended Category III AIF issues and redeems units continuously, but the Manager can still fix redemption windows and a lock-in.
After the lock-in ends. The investor can redeem, but usually not for free. The PPM sets an Exit Load — an extra charge on redemptions made after the lock-in but before the fund's full tenure ends. Exit Load can run from 0% to 5% of NAV, and some Managers charge a higher rate the earlier an investor exits.
Redemption Gates. Even after the lock-in, the PPM can cap how much of the fund an investor may redeem in any one redemption period. This spreads redemptions out, so the fund is not forced to liquidate a large chunk of its portfolio at once.
A worked example
Chennai-based investor Mr Iyer commits Rs 2 crore to a closed-ended Category III AIF with a 5-year tenure. The PPM sets a 2-year lock-in and an Exit Load of 3% for exits between year 2 and year 3, falling to 1% between year 3 and year 4, and nil after year 4.
Mr Iyer tries to redeem in month 18. He cannot — he is still inside the lock-in.
At the start of year 3, he redeems Rs 50 lakh. Because he is past the lock-in but inside the 3-year mark, he pays a 3% Exit Load:
Exit Load = 3% x Rs 50 lakh = Rs 1.5 lakh
Net proceeds = Rs 50 lakh - Rs 1.5 lakh = Rs 48.5 lakh
Had he waited until year 4, the same redemption would have cost him only Rs 50,000 in Exit Load, at the lower 1% rate.
Why NISM asks about it
Chapter 3, section 3.3.7.1 (Lock-in Period and Exit Load), sets the 3-year minimum tenure for closed-ended funds, the 2-year prevalent practice, and the 0-5% Exit Load range. Chapter 4 repeats the 2-year figure when comparing fund structures. Expect a question on the minimum tenure for a closed-ended fund and on whether the 2-year lock-in is a SEBI mandate — it is not.
Common exam traps
- The 2-year lock-in is common practice, not a SEBI-mandated minimum. Only the 3-year minimum tenure for closed-ended funds comes from the regulations.
- Lock-in and Exit Load are different things. The lock-in blocks redemption entirely; Exit Load is a charge on redemptions made after the lock-in ends.
- Redemption Gates cap the amount redeemable in a period — they do not extend the lock-in itself.
- Open-ended funds can still have a lock-in. Being open-ended only means units are issued and redeemed on a continuing basis, not that redemption is unrestricted from day one.
Check yourself
1.What fee is charged to investors on redemptions made after completion of the lock-in period but before the expiration of the stated fund tenure?
- a)Exit load
- b)Incentive fee
- c)Redemption gate
- d)Hurdle rate
Show the answer
Answer: (a) Exit load
This is the workbook's own sample question. Exit load is the additional fee charged on redemptions made after the lock-in ends but before the tenure expires, pre-defined in the PPM and ranging from 0 to 5 per cent of NAV. Option (c) is the near-miss: a redemption gate limits how much may be redeemed in a period; it is not itself a fee. An incentive fee rewards outperformance, and a hurdle rate is a threshold return, not a charge.
2.A Category III AIF investing in a pre-IPO deal in a growth-stage company that is about to file for an IPO may invest:
- a)up to 25 per cent of investable funds, with no lock-in
- b)up to 10 per cent of its investable funds, subject to a minimum lock-in of 6 months under the SEBI (ICDR) Regulations
- c)up to 10 per cent of investable funds, with a 12-month lock-in
- d)any amount, provided the shares are sold within 6 months of listing
Show the answer
Answer: (b) up to 10 per cent of its investable funds, subject to a minimum lock-in of 6 months under the SEBI (ICDR) Regulations
Before the IPO, the Category III AIF can invest up to 10 per cent of its investable funds in the shares of the company proposed to get listed, with the intent of selling at a higher premium. Such investments are subject to a minimum lock-in period of 6 months, as per the SEBI (Issue of Capital and Disclosure Requirements) Regulations. Note the two figures move together and are commonly swapped in questions — 10 per cent of funds, 6 months of lock-in.
3.Which section of the Private Placement Memorandum will most likely provide details on the prior experience of the Investment Manager of a Category III AIF?
- a)Investment Objective and Strategy
- b)Term of the Fund/Scheme
- c)Redemption
- d)Manager
Show the answer
Answer: (d) Manager
(This is a sample question from the NISM workbook.)
The "MANAGER / INVESTMENT MANAGER" section "STATES THE PRIOR EXPERIENCE OF THE FUND MANAGER(S) RESPONSIBLE TO TAKE INVESTMENT DECISIONS FOR THE FUND."
The other three sections each answer a different question, and all four are worth knowing as a set:
Section What it covers Investment Objective and Strategy "The TARGETED SECURITIES, INVESTMENT STYLE, SECTORS, GEOGRAPHIC FOCUS, and such other factors" Term of the Fund/Scheme "FUND STRUCTURE, TERM, WHETHER OPEN OR CLOSED FUND, FINAL CLOSING DATE AND APPLICABLE EXTENSION PERIODS" ⚠️ Manager ⚠️ "PRIOR EXPERIENCE OF THE FUND MANAGER(S)" Redemption "The PERIOD DURING WHICH INVESTORS CAN REDEEM... the LOCK-IN PERIOD AND THE REDEMPTION FEES OR EXIT LOAD" The workbook is emphatic that these should be read before subscribing: "Investors, before investing, SHOULD PARTICULARLY LOOK AT SOME OF THE CRUCIAL CLAUSES IN THE PRIVATE PLACEMENT MEMORANDUM, TO GET DETAILED INSIGHTS ABOUT THE FUND."
And the Redemption section is often the decisive one. The chapter's own HNI example turns on it: a fund may have "ABOVE-AVERAGE RETURNS" and "AN EXPERIENCED MANAGER" and still be unsuitable "GIVEN THE LIQUIDITY CONSTRAINTS."
Where this is taught
Free preparation for NISM Series XIX-BRelated terms
- Category III AIFThe AIF category for funds running diverse or complex trading strategies with leverage — hedge funds and their kin — and the only category denied tax pass-through status.
- Dissolution PeriodThe period after an AIF scheme's liquidation period, entered with 75%-by-value investor approval, to sell unliquidated investments — ending in mandatory in-specie distribution of whatever remains.
- Liquidation PeriodThe 1-year period following expiry of an AIF scheme's tenure or extended tenure, for fully liquidating its assets and distributing the proceeds to investors.
- Redemption GateA limit, set by the manager in the PPM, on the maximum amount investors can redeem from a Category III AIF in each redemption period — over and above expenses, taxes and exit load.
- Pre-IPO StrategyAn AIF mandate to subscribe to a company's shares before its IPO at a discount to the issue price, accepting the ICDR lock-in that runs from the date of listing.
- NPS Tier-II Tax Saver SchemeA Tier II NPS option for Central Government subscribers with an active Tier I account whose contributions qualify for the old-regime deduction, subject to a three-year lock-in per contribution.