CAT III Alternative Fund: What are they? Are they risky?

There are a variety of investment options in the market. One of them is the Alternative Investment Fund or AIF, which comes under the SEBI (Alternative Investment Fund) Regulation, 2012. AIFs are special or unconventional funds that are not covered under the SEBI (Mutual Funds) Regulations, 1996, and SEBI (Collective Investment Scheme) Regulation, 1999.

It is basically a privately pooled investment that can be established in the form of a company, Limited Liability Partnership (LLP), trust, or a body corporate through three categories- Category I, Category II, and Category III.

Let's understand in detail how AIFs function before delving into details of AIF Category III funds.

What is an Alternative Investment Fund?

Unlike conventional forms of money-making instruments, an Alternative Investment Fund is a special investment category. It collects funds from various investors (both Indian or foreign sources). Foreigners, institutions and high net-worth individuals (HNIs) invest substantially in AIFs. These funds are then invested in accordance with the defined investment policy.

In India AIFs are regulated under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012.

AIF Category III Fund

According to SEBI, Alternative Investment Funds shall seek registration through any three categories. As per the BSE, Category III AIFs involve hedge funds or funds that function with a view to get short-term returns. Other funds that are open-ended are also classified as AIF Category III. No specific incentives or concessions are provided by the government or any other regulator to such schemes.

Category III AIF: Features

1. Category III AIFs can invest only up to 10 per cent of the investable funds in an Investee Company.

2. Large value funds for Category III accredited investors may invest up to 20 per cent of the total funds available for investment in an Investee company directly or through other AIF.

3.  Category III AIFs invest in securities of listed as well as unlisted investee companies, derivatives, complex or structured products or other AIF units.

4. It may also leverage through investment in unlisted or listed derivatives, subject to consent from the investors.

5. Category III funds may either be open-ended or close-ended.

6. The funds have to report to investors on a quarterly basis within 60 days from the end of the quarter.

7. Unlike Category I and II, Category III funds have to bear tax liability as they don't have the pass-through status.

Are Category III AIFs risky?

Category III AIF funds, which invest in public equities have low liquidity risk. On the other hand, alternative investment funds which are involved in real estate and private equity bear higher risk. The risks involved in Category III funds are similar to those in any market instrument. Investors are advised to consider their financial goals and needs before putting their money in the scheme.