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Indian investors have many options to grow their wealth, and mutual funds are one of them. However, Alternative Investment Funds (AIFs) have emerged as a compelling choice for those seeking exposure to unique investment opportunities. In this blog, we will delve into distinctions between AIFs and mutual funds, investment strategies, and their taxation.
Mutual Funds and AIFs in India—An Overview
AIFs (Alternative Investment Funds)
AIFs are privately pooled investment vehicles that collect funds from sophisticated investors, both Indian and foreign, for investing in accordance with a defined investment policy. They cater to High Net-Worth Individuals (HNIs) and institutional investors looking for exposure to alternative asset classes.
Mutual Funds
Mutual funds pool money from numerous investors to invest in a diversified portfolio of stocks, bonds, or other securities. They are regulated by the Securities and Exchange Board of India (SEBI) and are suitable for investors seeking professional management with relatively lower risk.
Key Differences Between AIFs and Mutual Funds
| Parameters | Mutual Funds | AIFs |
| Regulatory Framework | Regulated under SEBI Mutual Fund Regulations | Regulated under SEBI (AIF) Regulations, 2012 |
| Investor Eligibility | As low as ₹500 Minimum | Minimum ₹1 crore or fewer for some funds |
| Investment Strategy | Invest in listed equities and debt | Invest in unlisted equities, real estate, hedge funds, venture capital, etc. |
| Liquidity | Highly liquid with easy redemption | Lower liquidity with longer lock-in periods |
| Taxation | Taxed at the investor level based on holding period | AIF taxation varies by categories |
Click here to know the benefits of AIFs.
AIF Taxation
Category I and II AIFs: These funds pass on the income directly to investors (except business income), who then pay tax on it based on their tax slab.
Category III AIFs (Domestic): These are taxed at the fund level using complex rules. Investors usually don’t have to pay tax again on what they receive from the fund.
Category III AIFs (IFSC): These enjoy special tax benefits, such as no capital gains tax, lower tax on other income, and a 10-year tax holiday for the fund managers. They also don’t have to pay GST.
In short, Category I and II AIFs are generally tax-efficient for investors, while Category III AIFs—especially those based in IFSCs—offer more tax benefits to the fund itself.
Final Thoughts
While mutual funds offer simplicity and accessibility, investing in AIFs provide opportunities for diversification into alternative assets with the potential for higher returns. However, they come with higher risks and longer lock-in periods and are suitable for investors with a higher risk appetite and investment horizon. Understanding the nuances of each investment vehicle is crucial before making investment decisions.
