How Do Alternative Investment Funds
Differ from Traditional Investments?

In the world of investment, some common and popular investment products are traditional investments (Bank FDs, post office investments etc), Mutual Funds, Direct Stocks, etc. In our previous blogs, we had explained slightly different and not so common investment product and i.e. Portfolio Management Services (PMS). 

Now, in this blog, we will explore Alternative Investment Funds (AIFs) and how it is different from traditional investments.

In recent years, alternative investment funds, or AIFs, have captured a lot of interest from the investment community. Many investors are looking into new possibilities outside of the traditional investing options due to the increasing demand for diverse portfolios and higher returns. However, what specific differences exist between AIFs and traditional investments? And why may they be a desirable choice for investors? Let's get started.

What are the Traditional Investment Options?

Before exploring AIFs, it’s important to understand what traditional investments are. Traditionally, most investors have looked to bank FDs, Post office investments, PPF, National Saving Certificates, Kisan Vikas Patra, stocks, bonds, mutual funds, and real estate as their main investment vehicles. These investment types are well-established, liquid, and highly regulated. These are classified in four below categories. Here are some characteristics of traditional investments:

• Stocks: Proportionate ownership in a company (according to no. of shares) that allows you to benefit from capital appreciation and dividends, if distributed by company.
• Bonds & Debentures: Debt securities issued by Central Governments, State Government, companies or corporations that offer pre-fixed or variable returns. It is a kind of a debt given by investors to bond issuing company.
• Mutual Funds: It is a pooled investments from many investors and the money are managed by professionals that typically invest in stocks, bonds, commodities or other assets.
• Real Estate: Investments in property, offering the potential for rental income or value appreciation.

A large number of investors are familiar with these investment types, which are also reasonably simple and accessible.

What Are Alternative Investment Funds (AIFs)?

AIFs are investment vehicles that invest in non-traditional assets. These include private equity, venture capital, hedge funds, real assets, and distressed assets. AIFs offer lower correlation to traditional markets, making them ideal for diversification.

You can clearly see from the name itself that Alternative Investment Funds (AIFs) is “Alternative” to traditional investment.

It is relatively newer class of investment. AIFs include investments in non-traditional assets. These assets often have lower correlation to traditional investments, making them attractive for diversification.

AIFs can invest in a variety of assets such as:

• Private Equity: Investment is made in private companies, start-ups and growth-stage businesses.
• Venture Capital: Investment is made in high-growth start-ups in exchange for equity.
• Hedge Funds: These are Actively managed funds and investment is made in various asset classes with strategies like short-selling and leveraging.
• Real Assets: Investment is made in infrastructure, commodities, and even intellectual property.
• Distressed Assets: Investment is made in companies or assets that are financially distressed.

AIF Categories as per SEBI

• Category I: Primarily invest in Venture capital, Start-ups, Angel Funds, social venture, SME, and infrastructure funds.
• Category II: Primarily invest in Private equity, Fund of Funds and debt funds.
• Category III: Primarily invest in Hedge funds, Private Investment in Public Equity Fund (PIPE)

What are the Differences Between AIFs and Traditional Investments?

1. Risk and Return

   • In contrast to AIFs, traditional investments provide moderate returns with comparatively lower risk. Stocks and bonds may not yield as high of returns as alternative investments, even though they offer a consistent income stream (for bonds) or the possibility of capital growth (for stocks). 
   • However, due to the nature of their investments, AIFs are typically linked to higher risk. But because they can invest in emerging markets, creative businesses, and distinctive assets that traditional investment vehicles would overlook, they also offer the possibility of larger returns.

2. Liquidity

   • Traditional investments may be bought and sold quickly on public exchanges, such as the stock or bond markets, because they are usually more liquid. It is relatively easy for investors to enter or exit an investment.
   • On the other hand, AIFs are frequently less liquid. Investors must commit their money to many AIFs for long periods of time—up to ten years, in some cases. An AIF is a less flexible choice for people who might need quick access to their money because early withdrawals can result in penalties or losses.

3. Diversification

   • Diversification within the stock or bond market is possible with traditional investments, but investments are still subject to market fluctuations.
   • There are wide range of options for diversification in AIF. AIF invest in assets that are not heavily reliant on the stock and bond (debt) markets and are not significantly connected. By including distressed assets, real estate, and private equity, investors can mitigate market volatility and perhaps reduce the overall risk of their portfolio.

4. Regulation and Transparency:

Traditional investments are heavily regulated; publicly traded corporations must follow stringent reporting guidelines and disclose financial statements. Investors are better able to evaluate risk and make wise decisions because to this transparency.

• In other situations, AIFs are subject to less regulation. Some investors may find them more difficult to assess because to the lack of transparency. However, they are still subject to oversight by financial authorities, and many AIF managers provide regular updates to investors.

1. Management

   • Traditional investments don’t require much hands-on management. Investors can buy and hold, or choose from a range of mutual funds or exchange-traded funds (ETFs) that are passively managed.
   • AIFs, especially private equity and venture capital funds, require active management and deep industry knowledge and experience. The fund managers often take an active role in the businesses or assets they invest in, seeking to improve performance and drive value creation.

2. Minimum Investment Amount

   • In Traditional investments there are no such minimum investment required. Each product has different rules. For example, Bank FD can start from Rs. 1,000/-, Mutual Fund investment can start from Rs. 100/-. You can purchase even 1 share of listed company from stock exchange.
   • However, in AIF, minimum investment amount required is Rs. 1 Cr., which means it is suitable for high net-worth individuals.

What Are the Benefits of AIFs?

Despite their complexity and higher risks, AIFs offer various unique benefits that make them appealing to high net-worth investors:

1. Higher Returns Potential

   • Compared to ordinary investments, AIFs may yield higher returns since they generally assume greater risk. They make investments in emerging assets or industries with rapid growth. For example, when the underlying companies grow significantly, venture capital or private equity firms can yield huge returns.

2. Diversification

   • AIF is an option for high-risk investors who have previously made stock and bond market investments and have funds available for deployment. Beyond stocks and bonds, AIFs let investors to diversify their holdings. Investors may be able to lower the overall volatility of their portfolio by making investments in uncorrelated assets like real estate, hedge funds, or private equity.

3. Access to Alternative Asset Classes

   • AIFs provide exposure to asset classes that are usually unavailable through traditional investments, such as private companies, distressed debt, or niche sectors like infrastructure or commodities. This broadens an investor’s scope and opens up new opportunities.

4. Protection Against Market Volatility

   • AIFs, particularly those investing in real estate or private equity, can serve as a hedge against the volatility seen in stock markets. By being less correlated to traditional market movements, AIFs can help protect an investor’s capital in turbulent times.

5. Professional Management

   • Most AIFs are managed by experienced professionals who bring deep expertise in selecting and managing investments. This provides value to investors who may not have the necessary knowledge or time to manage these types of investments themselves.

Few Examples of AIF & their returns in last 3 and 5 years:

(as of 31.12.2024)

Source: https://pmsbazaar.com/

Conclusion

Although AIF carry a higher risk, alternative investment funds provide investors a unique opportunity to diversify their holdings and the potential for larger returns. 

It's crucial to analyze the risks and rewards of investing in AIFs, ascertain your investment horizon, take into account your current portfolio of other assets, and consult with a financial advisor who can help you understand the technicalities of this alternative investment world.

Need More Details on Alternative Investment Funds?

If you want to know more about Alternative Investment Funds, get in touch with us at +91 83900 40100 or email support@bonvista.in. Our experts will guide you through your investment journey and help you explore the right AIF opportunities. We are expert financial consultants in Nashik, helping clients make informed investment decisions and grow their wealth strategically.