SEBI’s recently introduced GARUDA framework, which allows eligible Alternative Investment Fund (AIF) schemes to launch faster, has put the spotlight back on an investment category that has expanded rapidly over the past decade. While AIFs have become an important source of capital for startups, private businesses and alternative assets, they remain less familiar than mutual funds for many investors.
Industry experts say the key difference lies in the type of investors they are meant for, the assets they invest in and the flexibility they offer fund managers.
Why AIFs are different from mutual funds
According to Chirag Shah, Executive Director, BlackSoil AMC, AIFs are privately pooled investment vehicles that invest in asset classes beyond traditional equities and bonds, including private equity, venture capital, private credit, real estate and infrastructure. Since these investments are relatively illiquid and often carry higher risk, they are designed for sophisticated investors who can stay invested for longer periods.
Thomas Stephen, Director and Head – Preferred at Anand Rathi Share and Stock Brokers, said one of the biggest differences is accessibility. While mutual funds are available to retail investors with investments starting from a few hundred rupees, AIFs generally require a minimum investment commitment of ₹1 crore per investor.
Stephen added that most AIFs are structured as close-ended funds with multi-year lock-in periods, unlike mutual funds that offer daily liquidity. This enables fund managers to invest in private market opportunities that conventional mutual funds cannot access.
Highlighting another distinction, Nirav Karkera, Head of Research and Fund Manager at W by Groww, said AIFs provide significantly greater investment flexibility. While mutual funds operate under stricter diversification and liquidity norms, AIFs can invest across privately held equity, private credit, derivatives and other alternative assets, and often run more concentrated portfolios. He also noted that AIFs may charge performance-linked fees in addition to management fees, unlike the standard expense ratio structure followed by mutual funds.
Understanding SEBI’s three AIF categories
According to experts, SEBI classifies AIFs into three categories based on their investment strategy, use of leverage and overall risk profile.
Category I AIFs invest in sectors considered economically or socially beneficial. According to Shah, these include venture capital funds, SME funds, infrastructure funds, social venture funds and angel funds. These funds primarily back startups, early-stage businesses and infrastructure projects, cannot use leverage beyond operational requirements and generally receive regulatory incentives, including pass-through taxation.
Category II AIFs are the largest segment of the AIF industry, Stephen said. They include private equity funds, private credit funds, real estate funds and fund-of-funds that do not fall under Categories I or III. Like Category I funds, they cannot use leverage except for day-to-day operational needs and also benefit from pass-through tax treatment.
At the other end of the spectrum are Category III AIFs, which pursue more sophisticated investment strategies. Nehal Meshram, Senior Research Analyst at Morningstar India, said these funds can use leverage, invest in listed and unlisted derivatives, and follow hedge fund-style long-short or absolute-return strategies. Unlike Categories I and II, Category III AIFs are generally taxed at the fund level and are subject to stricter regulatory oversight because of their use of leverage.
Karkera added that Category III funds typically deploy quantitative or trading-based strategies in listed markets, making them distinct from the private-market focus of Categories I and II.
Experts also note that although both AIFs and mutual funds are regulated by SEBI, they operate under different regulatory frameworks. As Stephen explained, mutual fund regulations are more prescriptive because they cater to retail investors, whereas the AIF framework relies more heavily on disclosures and investor sophistication.
With India’s AIF industry managing commitments of more than ₹15 lakh crore, experts expect AIFs to play an increasingly important role in financing startups, private businesses and other alternative asset classes. However, they emphasize that these products remain suitable primarily for sophisticated investors who understand the risks associated with illiquid, long-term investments and can meet the minimum investment threshold.