Alternate Investment Funds: A Risk Worth Taking? EXPLAINED

The market forecasts that by 2026, Alternate Investment Funds could amount to 20 per cent of India's entire AUM, which is anticipated to increase twofold in the following 5 years

By Diwakar Rana

Alternate Investment Funds provide investors with distinctive avenues to branch out their portfolios ahead of conventional assets like stocks and bonds. In this editorial, we explore the domain of AIF, studying the approaches that can facilitate maximizing investment returns while diminishing risks.

From comprehending the important principles of risk and return in alternate investments to examining diversification techniques and regulatory considerations, this all-inclusive guide intends to provide investors with the information and resources required to sail across this popular investment landscape.

Introduction to Alternate Investment Funds

In India, AIFs are classified into 3 categories. Alternative investments signify 12 per cent of India's AUM and are the booming division with a 24 per cent compound growth rate. The market forecasts that by 2026, these funds could amount to 20 per cent of India's entire AUM, which is anticipated to increase twofold in the following 5 years. Justifying the numbers above, the alternate investment funds offer a pool of benefits and challenges as investing in AIFs can encompass diversification, conceivable higher returns, and exposure to unique investment prospects. On the other hand, challenges comprise greater fees, less liquidity, and amplified complexity in contrast with old-style investments.

Understanding Risk and Return

• Risk Assessment – The Category 1 & 2 AIFs time and again hold greater risks because of their illiquid nature, market unpredictability, and density. Identifying and calculating these risks is vital for formulating knowledgeable investment choices. On the other hand, category III AIF which invests in listed securities tends to provide more liquidity to the investor.


• Relationship between Risk and Return - In a common setting, alternate investments with above-average risk are likely to give better returns. Harmonizing risk and return is fundamental to boosting investment performance while handling risks efficiently via suggested/ proposed strategies.

Strategies for Maximizing Returns

• Leveraging Financial Instruments and Derivatives - Financial instruments and derivatives can lend a hand to improve revenues while flagging any potential red alerts against risks in AIFs. In addition, statistics from the Securities and Exchange Board of India (SEBI) represent a substantial surge in Assets Under Management (AUM) within AIFs, touching Rs 10.84 lakh crore, in addition to a 44 per cent annual proliferation in market share.


• Active Management vs. Passive Management - Choosing between active and passive management strategies in AIFs is essential. Active management aims to outperform the market through strategic decisions, while passive management seeks to replicate market performance at a lower cost.

Diversification Techniques for Risk Management

• Asset Class Diversification - Diversifying across different asset classes, such as equities, fixed income, real estate, and commodities, can help spread risks and enhance portfolio stability in AIFs. In a favorable market, we anticipate the AIF industry will grow to Rs 43.64 lakh crore by 2028. 


• Geographic and Sector Diversification - Geographic and sector diversification involves investing in various regions and industries to reduce risk. This strategy can help mitigate the impact of local economic downturns or sector-specific challenges.

Due Diligence and Selection Process

• Evaluating Fund Managers and Track Records - Look for fund managers with a solid track record - not just on paper, but also in their ability to navigate stormy financial waters. Trust your gut as much as the numbers, because sometimes a good vibe can lead to great returns.


• Assessing Fees and Expenses - Nobody likes surprise charges, especially when it comes to their hard-earned money. Before diving into an alternate investment fund, ensure you are crystal clear on all the fees and expenses involved.

Regulatory Considerations and Compliance

Regulations are like protective bubble wrap around the investments. Understanding the regulatory framework governing alternate investment funds is like knowing the game's rules before you play. Stay informed, stay compliant, and your investment journey will be a smoother ride.

Monitoring and Performance Evaluation

• Key Performance Indicators - Measuring performance shows how far you have come and how much further you can go. Keep an eye on key performance indicators to gauge the health of your alternate investment fund.


• Periodic Review and Rebalancing Strategies - Your investment portfolio needs a refresh too. Periodic reviews and rebalancing strategies are like gatekeepers for your finances - keeping things precise and maximizing your returns. Stay on your toes, adapt to market changes, and watch your investments.

It is noteworthy that in the previous 5 years (from June FY19 to FY24), the PMS (Portfolio Management and AIF) market has witnessed an incredible Compound Annual Growth Rate (CAGR) of 26 per cent, ensuring remarkable assets under management (AUM) of Rs 13.74 lakh crore as of FY24. This progress evaluation exceeds the mutual fund industry's accomplishment, which recorded a CAGR of 17 per cent and managed an AUM of Rs 55 lakh crore as of March 2024, emphasizing the industry's expansion at more than twice the rate.

Wrapping up, AIFs give investors chances to approach a wider scope of asset classes and possibly enrich their portfolio performance. By executing sound strategies, conducting thorough examinations, and staying well-informed of regulatory requirements, investors can successfully handle risks and make every effort to gain ideal returns in the dynamic sphere of alternate investments. Embracing the
principles summarized in this article can allow investors to make learned decisions and unlock the full potential of AIFs in achieving their financial goals.

The author is the Senior Research Analyst at Prudent Equity.

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