HDFC Asset Management Company (AMC) is one of India’s largest mutual fund houses with schemes across various categories. HDFC Mutual Fund has marked its entry into the alternative asset space with the launch of its first Alternative Investment Fund (AIF) product.

HDFC Select AIF FOF – I is a Category II AIF (Fund of Funds) that will invest in venture capital (VC) and private equity (PE) AIFs, broadly split equally between the two, with no pre-defined sector.

The FoF is currently open for subscription, and as per SEBI regulations, the minimum commitment amount in an AIF is Rs. 1 crore. The AMC will take this commitment amount over a period of five years to make the scheme accessible to more investors. HDFC AMC is planning to raise Rs 1,500 crore with an option to collect up to Rs 1,500 crore more through the Greenshoe option. The FoF is expecting its first closure before the end of March.

According to SEBI, there are currently over 900 registered AIFs in India. AIFs have expanded dramatically in all three categories. The industry has the potential to grow 3x in the next five years, in line with the growing aspirations of a wealthy India. It demonstrates that AIFs are popular among Indian investors. In this article, we will go over all there to know about AIFs.

What is Alternate Investment Fund (AIF)?

Alternative Investment Funds are a type of investment that is distinct from traditional investment instruments. These schemes provide a better rate of return than traditional alternatives but require a larger investment amount and are riskier than mutual funds. These funds are not aimed at the general public; rather, they are aimed at skilled investors such as HNIs from India and abroad with huge sums of money to invest.

Alternative Investment Funds (AIFs) are specified under Regulation 2(1) (b) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012. It is a privately pooled investment fund that invests in hedge funds, private equity, venture capital, and other investment types (whether from Indian or foreign sources). AIFs are typically used by institutions and HNIs for large investments, although they are likely to be available to midsize retail investors as well. AIFs can be formed as a corporation, trust, body corporate, or Limited Liability Partnership (LLP), among other structures. As a result, in India, AIFs are private funds that are not subject to the jurisdiction of any regulatory agency.

Types of Alternate Investment Funds (AIF):

SEBI has classified AIFs into 3 categories as under:

Category I

AIFs under this category mainly invest in start-ups, SME’s or any other sector and new economically viable corporations that have high-growth potential. They include the following:

• Infrastructure Funds: This fund invests in companies engaged in infrastructural works like constructing airports, railroads, etc. Investors who are bullish on infrastructure development invest their money in these funds. 
• Venture Capital Funds (VCF): The fund invests money in promising entrepreneurial businesses that need large amounts of capital. New-age entrepreneurial firms that require large financing during their initial days can approach VCF. These funds invest in start-ups with high-growth prospects. HNIs investing in VCFs adopt a high-risk, high-return strategy while allocating their resources.
• Angel Funds: It invests in new-age start-ups that do not receive investment from VCF. Each angel fund investor allocates a minimum of Rs 25 lakh.
• Social venture Fund (SVF): Funds investing in a socially responsible business are social venture funds. The fund puts money into businesses that come under philanthropic activities. They aim to bring a change in society through investments but, at the same time, have a scope of generating decent returns for investors. 

Category II

This includes Alternative Investment Funds such as private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other Regulator.

• Private Equity Funds: Private equity funds invest in unlisted private businesses that face difficulty in raising capital by issuing equity and debt instruments. Usually, these funds come with a lock-in period which ranges from 4 to 7 years. 
• Debt Funds: This fund primarily invests in debt securities of unlisted companies that follow good corporate governance models and have high-growth potential. However, they are not for conservative investors as they have a low credit rating. 
• Fund of Funds (FoFs): Funds of funds are schemes that aim to invest in other Alternative Investment Funds. 

Category III

This includes AIFs such as hedge funds or funds which trade with a view to making short-term returns or such other funds which are open-ended and for which no specific incentives or concessions are given by the government or any other Regulator.

• Hedge Funds: These funds pool money from accredited investors and institutions and invest in both domestic and international debt and equity markets. They adopt an aggressive investment strategy to generate returns for investors. However, hedge funds are expensive as fund managers can charge an asset management fee of 2% or more. They can also levy 20% of the returns generated as their fees.
• Private Investment in Public Equity Fund (PIPE): This type of funding scheme invests in public firms by buying their shares at discounted prices. 

Who should Invest in AIFs?

Investors who are seeking to diversify their investment portfolio can invest in AIFs if they meet the eligibility criteria as under:

• Resident Indians, foreign nationals and Non-resident Indians (NRIs), except those outside Canada and the US, are eligible to invest in these funds. However, US-based NRIs can invest in the fund, provided they are in India at the time of investment.
• The minimum investment amount is Rs 1 crore for investors, whereas the minimum investment amount for directors, employees, and fund managers is Rs 25 lacs
• AIFs come with a minimum lock-in period of three years. 
• The number of investors in every scheme is restricted to 1,000, except for angel funds, where the number of investors goes up to 49.

About the fund – HDFC Select AIF FOF – I

HDFC Select AIF FOF – I will invest in 12-15 Venture Capital/Private Equity funds across stages (funds that invest in early and late-stage ventures), sectors and vintages (different starting years for investing investors’ money) as well as the underlying fund). The criteria for shortlisting the funds are:

– Investor profile of the underlying funds (In terms of investor profile, funds that attract domestic and foreign institutional investors will be viewed more positively.)

– The credibility of the fund team

– Fund exit record

– Governance standards

The tenure of HDFC Select AIF FOF – I will be 11 years, with an option to extend the tenure by up to 2 years (one year at a time), subject to the approval of two-thirds of the investors by the value of their investment. The tenure of the underlying funds will range from 7-10 years (plus two years). The FoF expects to start retiring capital (returning money to investors) in the sixth year. To ensure skin in the game, the AMC will deposit at least 10% of the capital raised from customers into the fund from its own capital.

There will be two share classes of investors in the FoF scheme.

– Class A will be charged an annual management fee of 2% (of the committed amount for the first five years and, thereafter, of the net capital invested).

– Class D will be charged an annual management fee of 2.5%.

In addition, both segments will be charged a one-time set-up fee of up to 0.1%, annual operating expenses of up to 0.15% and a performance fee (profit share) of 20%.

Tax Implications

• Categories I and II of AIFs are not subject to taxation in the hands of the AIF. However, if you earn by investing in them, taxes will be implemented based on your current tax slab.
• If you invest in an AIF that allocated its funds to equity investments, you have to pay a capital gain tax of 10% for the long term and 15% for the short term. 
• Category III funds get taxed at the maximum marginal rate of 42.7%. In case you invest in them, you receive your earnings after this deduction.

Since the underlying funds of HDFC Select AIF FoF – I are Category-I and Category-II AIFs with tax pass-through status, the whole capital will be returned to the FoF. (no TDS or tax deducted at source). Before passing on investment profits to investors, the FoF will deduct 10% TDS.

Fund Outlook – HDFC Select AIF FoF – I

HDFC Select AIF FoF scheme will provide investors with an opportunity to invest in multiple AIFs without having to invest huge amounts individually in each of these funds. This AIF-based FoF scheme is for investors who seek diversified exposure in the unlisted space – with a portfolio comprising investments in zero-day to pre-IPO stage ventures.

Diversification is important for all investors, but it is more vital for HNIs with big ticket sizes. AIFs enable investors to diversify their portfolios and serve as a cushion during market turbulence. The massive pooled sum enables fund managers to devise adaptable alpha-generating strategies.

However, do note that AIFs are highly risky in nature as compared to equity mutual funds but have less volatility when compared to direct equities. The ongoing geopolitical tensions, hike in rates again to curb the high inflation, and the fears of a possible recession may cause a significant risk to economic growth and continue the prevailing high market volatility. These factors, among others, may impact the growth of the companies the underlying fund invests in and may have a negative impact on the scheme’s performance in the near term.

Thus, this scheme is suitable only for investors, especially HNIs, who have a better understanding of AIFs and have a high-risk profile and long investment horizon that helps sustain the market volatility.