NISM Series XIX-C · Chapter 6: Alternative Investment Funds in India and its Suitability

L1 · Foundation

Foundation — How the Indian AIF industry grew, and the eleven fund types

The evolution from the 1988 Venture Capital Guidelines to the AIF Regulations, the parallel story of hedge funds, what "privately pooled" excludes, and each of the eleven fund types SEBI recognises.

22 min read · Worth 3% of the paper · Written from pages 77–103 of the official NISM workbook · Updated 18 September 2026

6.1 The evolution of venture capital and private equity

The evolution of alternative investments in India can be traced to the Venture Capital Guidelines notified on 25th November, 1988 by the Government of India which initially provided a restricted scope for venture capital (VC) financing.

The scope for VC was broad-banded by SEBI in 1996 by notifying a new set of regulations for the VC industry called the SEBI (Venture Capital Fund) Regulations, 1996 which brought the entire spectrum of private capital investment in unlisted companies into the ambit of institutional investment.

Subsequently, tax breaks were given to VCFs at fund level and the SEBI regulations were also revised following the recommendations of the K.B. Chandrasekhar Committee in 2000.

Three dates so far: 1988 Venture Capital Guidelines, 1996 SEBI (VCF) Regulations, 2000 K.B. Chandrasekhar Committee.

In the growth phase that followed from 2003 with the emergence of a strong domestic capital market and the impressive growth of corporate India, many Venture Capital Fund and Private Equity Funds emerged mainly with off-shore capital. Domestic institutions such as ICICI, UTI etc. evolved into full-fledged private equity players.

The landmark deals

From a business perspective, from 2001 onwards, Indian industry was on a consolidation drive in various sectors. This corporate growth initiative coupled with an investor friendly regime and good economic conditions led to a spurt in private equity activity in India.

The first characteristic private equity transaction in India is arguably the USD 292 million investment made by Warburg Pincus in Bharti Televentures Ltd which also resulted in a successful exit strategy for the fund when Bharti was taken public with its IPO in 2002.

In the initial stages, though private equity was largely confined to the information technology sector, by the end of 2007, the sectoral bias was largely removed and private capital had got extended to several other sectors. In addition, the Indian market also saw the emergence of buyout transactions spearheaded by funds such as Blackstone, KKR, Actis etc. which acquired controlling interest in both listed as well as closely held companies. The buyout of Flextronics Ltd by KKR in 2006 was a landmark deal.

Two deals to remember: Warburg Pincus in Bharti Televentures (USD 292 million, IPO exit in 2002) and KKR's buyout of Flextronics Ltd in 2006.

In the aftermath of the Global Financial Crisis 2008, the industry was subdued till 2012 until growth started to pick up significantly from 2012 mostly due to the introduction of the SEBI (Alternative Investment Funds) Regulations. But the period between 2011 and 2019 can be termed as the consolidation and transformation phase during which some of the older funds exited and newer funds consolidated their presence. This phase also marked the transformation of a VC and PE industry into an AIF industry.

The parallel story of hedge funds

The term "hedge funds", first came into use in 1949, when Alfred Winslow Jones's company, A.W. Jones & Co. launched the first hedge fund. "Hedge Funds" were described as any investment fund that used incentive fees, short selling, and leverage to maximize returns for the investors.

Three defining features from the original description: incentive fees, short selling, and leverage.

Over time, hedge funds began to diversify their investment portfolios to include other financial instruments such as fixed income securities, convertible securities, currencies, exchange traded futures contracts, commodity futures and commodity options.

The Indian position:

Indian capital markets witnessed significant growth in the 1990s. With the notification of rules and regulations governing Portfolio Managers and SEBI (Mutual Funds) Regulations, the asset management business took shape in the private sector in India.

Foreign Investors were investing significant funds through Hedge funds and Funds-of-Funds, set-up in offshore jurisdictions. Such funds invested directly in Indian Securities Market, or through Offshore Derivative Instruments (ODIs), issued by Foreign Institutional Investors (FIIs) against underlying Indian securities.

The index: Eurekahedge India Long Short Equities Hedge Fund Index is an equally weighted index of 15 constituent funds... The index is base weighted at 100, as on December 1999. And the observation: the India-focused hedge funds have shown consistent returns, even after a decrease in the index value during the Global Financial Crisis of 2008.

And the regulatory gap that existed before 2012:

However, no hedge funds were domiciled in India. Offshore hedge funds were not able to offer their products to Indian investors within India as there was no regulatory regime for hedge funds to be set up or marketed in India.

Considering the lack of a separate regulation for hedge funds and other restrictions under FEMA, hedge funds had limited options for marketing their products to Indian investors. SEBI provided a limited window upto 2012 for hedge funds to register under the SEBI (Foreign Institutional Investors) Regulations as an FII with additional safeguards. Under the SEBI (Alternative Investment Funds) Regulations, 2012, Hedge Funds were classified under "Category III AIF" which follows diverse and complex investment strategies, akin to investment strategies followed by Hedge Funds, globally.

The trends after 2012

The workbook lists ten. The most examinable:

The industry evolved from a predominantly venture capital and private equity industry into a full-fledged alternative investment industry spanning several alternative asset management funds and UHNIs / family offices.
private equity inflows and activity reached record levels in Asia Pacific region with India registering highest growth in 2017 and 2018.
The significant emergence of domestic capital to support the AIF industry has been evident during this phase.
Government reforms were introduced to provide tax incentives to start-ups, drawing capital from Sovereign Wealth Fund, Pension Funds, Foundations, Insurance Companies, Banks, Charitable Organizations, Family Offices and High Net Worth Individuals.
The domestic AIF market grew by identifying new alternative investment opportunities such as pre-IPO financings, special situations such as stressed asset auctions under the Insolvency and Bankruptcy Code 2016, debt resolution refinancing with banks, M&A financings and co-investments, real estate debt financings, mezzanine funding, infrastructure debt and equity funds.
The emergence of AIF schemes with focus on listed market space is a new phenomenon, taking long-short positions and focusing on merger arbitrage, buybacks, de-listings, open offers under the Takeover Code, rights offers and hedging.
Rationalisation of Expense Ratio charged by equity-oriented Mutual Fund schemes... have encouraged mutual fund managers to exit and launch their own vehicles as AIFs in India, since Managers of AIFs are flexible to charge Performance-based Fees, on the 'Additional Return' earned by the fund above the 'Reference Hurdle Rate'.
The 2025 budget proposed dedicating a major part of a proposed INR 10,000 crore Fund of Funds (FoF) to new-age technology, artificial intelligence, and machine learning.

6.2 What is — and is not — an AIF

The SEBI (Alternative Investment Funds) Regulations 2012... define the term 'Alternative Investment Fund' (AIF) as one which is primarily a privately pooled investment vehicle... only a 'privately pooled' structure with funds pooled from India or abroad for a defined investment policy is to be considered as an AIF.

The words 'privately pooled' denote that the fund is pooled from select investors and not from the general public at large. These private investors are sourced from categories such as institutions and HNIs who can understand the nuances of higher risk taking and complex investment arrangements.

The three exclusions

Nonetheless, the following categories are explicitly excluded from this definition:

Any fund which is a mutual fund or a collective investment scheme as per SEBI regulations.
Family trusts, ESOP or other such employee benefit trusts, holding companies, SPVs set up for securitisation or other such purposes.
Funds set up under RBI regulations such as securitisation companies or under the purview of any other regulator.

And the unifying principle:

It may be noted that the exclusions are either private funds of a company, business or a family or those that are regulated by other regulators such as RBI or IRDAI or PFRDA or IFSCA.

That single sentence organises all three exclusions: something is excluded either because it is a private arrangement of one family or business, or because another regulator already governs it.

The eleven fund types

6.2.1 Venture Capital Fund — "an AIF which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model and shall include a migrated venture capital fund".

Two definitions travel with it. A "Start-up" means a private limited company or a limited liability partnership which fulfils the criteria for start-up as specified by the Department of Promotion of Industry and Internal Trade... vide notification no. G.S.R.127(E) dated February 19, 2019. And a "Venture capital undertaking" refers to domestic company which is not listed on a recognised stock exchange at the time of making investment.

Venture capital can be termed as the first stage of institutional financing in an early-stage company or start-up, generally after the angel funds are successfully raised... It is mostly applicable to asset light businesses that are intensive in technology, intellectual property or digital media applications.

6.2.2 Migrated Venture Capital Fund — "a fund that was previously registered as a Venture Capital Fund under the SEBI (Venture Capital Funds) Regulations, 1996 and subsequently registered under the SEBI (AIF) Regulations, 2012 as a sub-category of Venture Capital Fund under Category I AIF". The facility of migration to SEBI (AIF) Regulations was available till July 19, 2025 only.

migrated VCFs are not permitted to launch any new schemes. However, extension of the tenure of existing schemes of the migrated VCFs are permitted upto 2 years, subject to approval of two-thirds of the unit holders by value. And a further concession: VCF schemes whose liquidation period expired but was not wound-up, and are migrated to SEBI (AIF) Regulations, such migrated VCF schemes are granted an additional liquidation period till July 19, 2026.

6.2.3 Angel Fund — "a sub-category of Category I AIF that raises funds from accredited investors and invests in accordance with the SEBI (AIF) Regulations". Angel Investor means an accredited investor or key management personnel of an angel fund or its Manager who invests in an angel fund.

Note the words raises funds from accredited investors — which is why a retail investor cannot invest in an angel fund, the answer to sample question 3.

6.2.4 Private Equity Fund — "an AIF which invests primarily in equity or equity linked instruments or partnership interests of investee companies according to the stated objective of the fund". A footnote defines equity linked instruments as instruments convertible into equity shares or share warrants, preference shares, debentures compulsorily or optionally convertible into equity.

private equity fund is primarily an equity-based investment fund but unlike venture capital funds which are focussed on early stage investments, private equity funds are mostly involved in later stage financing in business entities that have established a business model and need to be scaled up for further growth.

6.2.5 Debt Fund (Private Debt Fund) — "an AIF which invests primarily in debt securities of listed or unlisted investee companies or in securitized debt instruments as per the stated objectives of the Fund."

Private debt, a.k.a. private credit market is growing in India in scale due to its flexibility in structuring as compared to conventional bank credit or public capital market debt that are subject to stringent regulations.

Why private debt is alternative: Many types of debt that are part of the private debt market are considered to be alternative investments because of their illiquidity and often because they are not commonly held by traditional investors. Even listed companies issue debt securities such as non-convertible debentures (NCDs) and bonds through private placement that are not available in the traditional investment route.

On venture debt: Usually, venture debt comes with an equity kicker upto 10 percent of the loan amount. Being unsecured lending to start-ups & asset light businesses, venture debt relies heavily on the due diligence and growth trajectory of the borrower as perceived by its equity investors. And a market figure: as of 2025, venture debt constitutes only 8-9 percent of the overall venture capital financing in India, and therefore, has headroom for scalability.

And leveraged loans: Some private debt funds also finance sub-ordinate debt, in the form of 'leveraged loans' which is used in funding companies with high amount of senior debt on their balance sheet. These support stressed asset resolutions, securitised debt issuances..., promoter financing through structured credit (often using promoter shares as collateral) and LBO financing.

6.2.6 Infrastructure Fund — "an AIF which invests primarily in unlisted securities or partnership interest or listed debt or securitised debt instruments of investee companies or special purpose vehicles engaged in or formed for the purpose of operating, developing or holding infrastructure projects".

Sovereign Wealth Funds, Multi-lateral Funds and Thematic AIFs are the key investors in this space, due to its high illiquidity, long gestation risk in project implementation and long amortisation of the debt.

6.2.7 SME Fund — "an AIF which invests primarily in unlisted securities of investee companies which are SMEs or securities of those SMEs which are listed or proposed to be listed on a SME exchange or SME segment of an exchange". SME shall have the same meaning as assigned to it under the Micro, Small and Medium Enterprises Development Act 2006, and Both BSE and NSE runs a separate segment for SME companies, whose eligibility criteria and compliances... are more relaxed than the main board listing criteria.

6.2.8 Hedge Fund — "an AIF which employs diverse or complex trading strategies and invests and trades in securities having diverse risks or complex products including listed and unlisted derivatives".

6.2.9 Social Impact Fund — "an AIF which invests primarily in securities or units or partnership interest of social ventures or securities of social enterprises and which satisfies the social performance norms laid down by the fund".

'Social Ventures' are formed with the purpose of promoting social welfare, solving social problems, or providing social benefits. The four listed forms: Public Charitable Trusts registered with the Charity Commissioner; Societies registered for charitable purposes or for promotion of science, literature, or fine arts; Section 8 company, registered as per the provisions of the Companies Act, 2013; Micro-finance Institutions.

6.2.10 Special Situations Fund — a sub-category in Category I AIFs which are distressed debt funds now specifically defined by SEBI. SSFs can acquire debt / equity by participating in debt resolutions under the IBC 2016. They can also finance companies in default to banks and NBFCs for a period of not less than 90 days, acquire stressed loans and security receipts issued by asset reconstruction companies.

6.2.11 Corporate Debt Market Development Fund — a close-ended AIF formed as a trust and with a 15-year tenure from the date of its first closing. Units... are issued to Asset Management Companies and specified debt-oriented schemes of mutual funds. The purpose of such fund is to purchase corporate debt securities from debt-oriented mutual fund schemes during periods of market dislocation as may be decided by SEBI.

The three conditions on what it may buy:

Corporate Debt securities shall be listed and have an investment grade rating.
Residual maturity of such securities shall not exceed five years on the date of purchase.
Such securities have no material possibility of default or adverse credit news or views.

During such periods when there is no market dislocation, the fund will invest in liquid and low-risk debt instruments, in a manner specified by SEBI.

Think of it like this

The wedding invitation and the newspaper advertisement

A family printing three hundred cards for a wedding is doing something different in kind from a company placing a full-page advertisement. The cards go to people the family has chosen; the advertisement goes to whoever happens to open the paper.

That is what privately pooled means: the fund is pooled from select investors and not from the general public at large. These private investors are sourced from categories such as institutions and HNIs who can understand the nuances of higher risk taking and complex investment arrangements.

And the exclusions follow the same instinct. Family trusts, ESOP or other such employee benefit trusts, holding companies, SPVs are excluded because they are the family's own money, not a pooling of outsiders; mutual funds and RBI-regulated vehicles are excluded because the exclusions are either private funds of a company, business or a family or those that are regulated by other regulators such as RBI or IRDAI or PFRDA or IFSCA.

The nursery, the orchard and the trading floor

A nurseryman raises saplings — most die, a few become magnificent trees, and nobody can tell which is which for years. An orchardist buys established trees and improves the yield. A commodities trader never owns a tree at all; he takes positions on the price of mangoes and may be short as easily as long.

Those are the three categories. Category I AIF... invests in start-ups, early stage ventures, social ventures, SMEs, infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable. Category II AIF is an AIF that does not fall in Category I and Category III and which does not undertake leverage or borrowing other than as permitted. And Category III AIF is an AIF that employs diverse or complex trading strategies and may employ leverage, including through investment in listed or unlisted derivatives.

Note that Category II is defined negatively — it is whatever is left over — which is why private equity and debt funds sit there without any special incentive.

Buying flats in a building, versus buying shares in the builder

Two people put Rs 1 crore into the same project. One buys a specific flat, registered in his own name — he can sell it, mortgage it, or live in it. The other buys shares in the company that owns the whole building; he owns a proportion of everything and a particular nothing.

That is the difference between PMS and an AIF. PMS are offered individually to each investor or "client" of the portfolio manager. Hence, the investor "owns" every security purchased by the Portfolio Manager. At the end of the day, the securities under the portfolio are held in the DEMAT account of the investors vs. pooled DEMAT account for AIF. This is different from investing in AIFs, where the investors own "units" of the fund representing the underlying security. AIFs act as "pooling vehicles" and collectively invest funds on behalf of all the investors, which is not the case in PMS.

That single structural difference explains the lock-in too: PMS investors have the choice to withdraw funds at any time since the securities are in their own name.

The chef who cooks the dish and the chef who buys the restaurant a share

In one kitchen the chef is a salaried employee who leaves at nine. In another, the chef has bought a stake in the restaurant with his own savings. You may trust both, but you will sleep differently knowing which is which.

That is the skin in the game difference between a PMS manager and an AIF manager. For PMS: No requirements for manager contribution (skin in the game), however the manager needs to have a networth of INR 5 crores at all times. For a Category III AIF: Manager or Sponsor should hold/invest at least 5% of the corpus or INR 10 crores, whichever is lower; however, there are no networth criteria.

Note how neatly the two swap places — the PMS manager must have net worth but no commitment; the AIF manager must have commitment but has no net worth test.

The batsman who scores because the pitch is flat, and the one who scores on a turning track

Two batsmen both make eighty. One did it on a batting paradise where everyone made runs; the other did it on a crumbling pitch where the next highest score was twenty. Only the second has demonstrated skill.

That is the distinction between beta and alpha. "Beta" measures systematic risk which is the change in the returns earned by the fund portfolio, on account of a change in the returns on a broad-based index. Alpha, in the second of its two senses, represents an expected superior profit due to the use of skill of the fund manager in the selection and allocation of investments... if the investments are picked carefully using investment strategies and the portfolio makes more than the market returns, the excess returns or the 'alpha' is attributable to the superior skill of the fund manager.

And the honest caution that follows: a fund invested in small-cap and mid-cap securities will have a high portfolio beta, and High beta investments are likely to outperform the benchmark during bull markets, but are also likely to underperform during bear markets. Flat-pitch runs are not skill.

Owning the sugar mill and also the sugar futures

A man who owns a sugar mill and then buys a fund that invests chiefly in sugar companies has not diversified. He has doubled down, though his statement now shows two line items instead of one.

That is why the workbook insists on looking through the fund: Keeping in mind that Category III AIFs further can also invest in traditional assets, such as listed or unlisted equities with additional short exposure to create market neutral strategies, it is important to allocate funds strategically in order to avoid further concentration of the portfolio.

The worked example makes the arithmetic plain. Mr X caps any asset class at 40 per cent, and a Category III fund holding 80% in domestic small-cap securities would push him past that limit: the investor will not want to allocate the entire amount to Category III AIF "B", as it would result in "direct and indirect" allocation of more than 40% towards Domestic Small-cap companies. The words that matter are direct and indirect.

Key terms in this chapter

AIF Exclusions: Mutual funds and collective investment schemes; family trusts, ESOP and employee benefit trusts, holding companies and securitisation SPVs; and funds under RBI or any other regulator. The unifying principle is that they are either private funds of one family or business, or already regulated elsewhere.
Angel Fund: A sub-category of Category I AIF raising funds from accredited investors. An angel investor is an accredited investor or key management personnel of the fund or its manager, and investment per investee company must be between Rs 10 lakh and Rs 25 crore.
Beta Management: Managing the systematic risk of a fund commensurate with its stated strategy. A portfolio of small and mid-cap securities carries a high beta that cannot be diversified away by spreading across industries, sectors or geographies, and high beta outperforms in bull markets while underperforming in bear markets.
Category I AIF: A fund investing in start-ups, early stage ventures, social ventures, SMEs, infrastructure or other sectors regulators consider socially or economically desirable. It includes venture capital, SME, angel, social impact, infrastructure and special situation funds, and the CDMDF.
Category II AIF: The residual category — any AIF not falling under Category I or III, which does not undertake leverage or borrowing beyond what the Regulations permit. Private equity funds, debt funds and pre-IPO funds sit here, receiving no specific incentive from government or regulator.
Category III AIF: A fund employing diverse or complex trading strategies that may use leverage, including through listed or unlisted derivatives. Hedge funds, short-term trading funds and open-ended funds sit here, and it is the riskiest of the three categories.
Concentration Limits by Category: A Category I or II AIF scheme may not invest more than 25 per cent of investible funds in a single investee company; a Category III scheme is capped at 10 per cent, reflecting the leverage and liquidity of what it trades.
Corporate Debt Market Development Fund: A close-ended Category I AIF formed as a trust with a 15-year tenure from first closing, whose units go to AMCs and specified debt-oriented mutual fund schemes. It buys listed, investment-grade corporate debt with residual maturity up to five years during periods of market dislocation.
Direct and Indirect Allocation: The principle that concentration limits must look through a fund to its underlying holdings. An investor capping an asset class must count both what he holds directly and what the funds he owns hold on his behalf.
Equity Kicker: The equity component attached to venture debt, usually up to 10 per cent of the loan amount, compensating the lender for making unsecured loans to asset-light start-ups.
Leveraged Loans: Sub-ordinate debt used to fund companies already carrying a high amount of senior debt, supporting stressed asset resolutions, securitised debt issuance, promoter financing against shares and LBO financing.
Material Risks for an AIF: Concentration risk, foreign exchange risk, leverage risk, realization risk, strategy risk, reputation risk, and extra-financial risks including ESG risk — all to be identified and reported to investors at predefined intervals.
Migrated Venture Capital Fund: A fund previously registered under the SEBI (VCF) Regulations, 1996 and subsequently registered as a sub-category of Venture Capital Fund under Category I. Migration was available only till 19 July 2025, and such funds may not launch new schemes.
Minimum Investment Ladder: Mutual fund Rs 500; Specialized Investment Fund Rs 10 lakh; Portfolio Management Services Rs 50 lakh; AIF Rs 1 crore — with Rs 25 lakh for employees of an AIF and no minimum for accredited investors.
National Investment and Infrastructure Fund (NIIF): Set up by the Government of India in 2015 as a Category II AIF to invest in infrastructure and strategic assets, alongside the DPIIT Rs 10,000 crore fund of funds for start-ups managed by SIDBI.
Pooled versus Individual Ownership: In PMS the investor owns every security bought for him, held in his own demat account. In an AIF the investor owns units of a pooling vehicle that invests collectively, with securities in a pooled demat account and trading only at fund level.
Private Debt Fund: An AIF investing primarily in debt securities of listed or unlisted investee companies or in securitised debt instruments. Private debt is alternative because of its illiquidity and because it is not commonly held by traditional investors.
Privately Pooled Investment Vehicle: The defining feature of an AIF — funds pooled from India or abroad from select institutional and HNI investors for a defined investment policy, and not from the general public at large.
SEBI (Venture Capital Fund) Regulations, 1996: The regulations that broad-banded venture capital, bringing the entire spectrum of private capital investment in unlisted companies into the ambit of institutional investment. They were revised following the K.B. Chandrasekhar Committee in 2000.
Social Venture: An entity formed to promote social welfare, solve social problems or provide social benefits — a public charitable trust, a society registered for charitable purposes or promotion of science, literature or fine arts, a Section 8 company, or a micro-finance institution.
Specialized Investment Fund (SIF): A product line under the SEBI (Mutual Funds) Regulations designed to bridge the gap between mutual funds and PMS, requiring Rs 10 lakh minimum investment, a sponsor separate from the manager with a three-year track record, and issued through a public issue.
Special Situations Fund: A Category I sub-category of distressed debt funds that may participate in IBC resolutions, finance companies in default to banks and NBFCs for at least 90 days, and acquire stressed loans and security receipts issued by asset reconstruction companies.
Two Connotations of Alpha: First, the excess return expected from assuming unsystematic risk arising from illiquidity or lower credit quality, measured after adjusting for risk differences against a benchmark. Second, superior profit from the fund manager's skill in selection and allocation — sometimes called alternative beta.
Venture Capital Guidelines, 1988: The Government of India guidelines notified on 25 November 1988 that mark the origin of alternative investments in India, providing an initially restricted scope for venture capital financing.
Venture Capital Undertaking: A domestic company that is not listed on a recognised stock exchange at the time the investment is made — the type of company a venture capital fund invests in.

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Original explanatory writing based on the official NISM workbook for Series XIX-C, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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