NISM Series XIX-A cheat sheet

AIF definition: a privately pooled fund incorporated in India that collects funds from investors for investing per a defined investment policy; it is not covered by SEBI mutual fund, collective investment scheme, or FDI/FPI regulations.

SEBI (Alternative Investment Funds) Regulations, 2012 govern AIFs; registration is mandatory before any activity, and AIFs are registered in three categories - Category I, II and III - with Category I further split into subcategories (venture capital, SME, infrastructure, angel).

Category I: funds investing in start-ups, early-stage ventures, SMEs, infrastructure or socially/economically desirable sectors; SEBI or the government considers their investment strategy as having a positive spillover on the economy.

Category I subcategories: Venture Capital Fund (VCF), SME Fund, Infrastructure Fund, and Angel Fund (a subcategory of VCF); each has its own investment conditions and minimum corpus norms.

Category II: funds that do not fall in Category I or III and do not undertake leverage other than as permitted; includes private equity funds and debt funds; they may use leverage only for day-to-day operations, not for investment purposes.

Minimum corpus: Rs 20 crore for most AIFs (Angel Fund minimum corpus Rs 10 crore); minimum investor commitment Rs 1 crore (Rs 25 lakh for angel investors in an Angel Fund, and Rs 5 crore for an accredited investor where applicable).

Investor limit: an AIF scheme may have up to 1,000 investors; a Category I or II scheme must have a minimum of 20 investors, with each investor committing at least the prescribed minimum; the manager/ sponsor must have a continuing interest of at least 2.5% of the corpus or Rs 5 crore, whichever is lower, in Category I and II.

Distribution rules: AIFs are private placements - no public offer, no advertisement, no solicitation; units are offered to identified investors via a private placement memorandum (PPM) and subscription agreement; the PPM must disclose strategy, risk factors, fees, conflicts and the fund's terms.

Category I and II AIFs are not permitted to invest more than 25% of the corpus in a single investee company (with higher limits for infrastructure funds in a single project); they must hold investments for a minimum of three years for close-ended schemes, and schemes are close-ended.

Tax and pass-through: Category I and II AIFs enjoy pass-through status for income (other than business income), so income is taxed in the hands of investors; the manager/sponsor is responsible for TDS and reporting; distribution compensation must be disclosed and cannot be structured to create conflicts with investors.

Eligibility for manager/sponsor: the manager must have a minimum net worth of Rs 2 crore (or an alternative as specified), and key personnel must meet SEBI's fit-and-proper and experience criteria; the sponsor/manager must maintain continuing interest in the scheme.

Scheme tenure: Category I and II schemes are close-ended; tenure is disclosed in the PPM, typically 5-10 years with possible extension up to 2 years with investor consent (for Category I and II, extension requires approval of at least 75% of investors by value).

Valuation: AIFs must value investments at least once every six months (quarterly for some), using internationally accepted valuation norms; a valuation policy must be disclosed, and Category I/II funds must appoint a custodian if the corpus exceeds Rs 500 crore.

Reporting: AIFs file quarterly and annual reports with SEBI, including scheme-level details; performance and NAV are reported to investors periodically, and any material change to the fund requires investor communication.

Distribution: AIF units are distributed through SEBI-registered intermediaries or directly by the manager; commission/trail must be disclosed in the PPM and in investor statements; distributors must comply with KYC, AML and PMLA requirements.

KYC/AML: all investors must complete KYC per SEBI/PMLA norms, with beneficial ownership identification; politically exposed persons and high-risk jurisdictions require enhanced due diligence, and records must be retained for at least five years.

Investor grievance redressal: AIFs must have a grievance redressal mechanism and disclose the same in the PPM; SEBI SCORES and the AIF industry body's arbitration mechanism can be used; complaints and their resolution must be reported.

Compliance: AIFs must appoint a compliance officer, maintain records, and file an annual compliance certificate; non-compliance can lead to penalties, suspension of registration or cancellation; the AIF must also comply with FEMA for foreign investors.

AIF vs mutual fund: AIFs are privately placed, have a higher minimum investment (Rs 1 crore), a limited investor base (up to 1,000), and are not subject to the same daily NAV/liquidity requirements; mutual funds are publicly offered and daily redeemable.

AIF vs PMS: Portfolio Management Services manage individual investor portfolios (minimum Rs 50 lakh) with direct securities ownership; AIFs pool investor money into a fund with a defined strategy and are close-ended with lock-ins.

Risk factors: illiquidity (no secondary market, lock-in of 3+ years), valuation uncertainty (unlisted securities), concentration risk (25% single-company limit), leverage risk in Category II, and execution/manager risk.

Suitability: Category I and II AIFs are suitable for investors with high risk appetite, long investment horizons and the ability to bear illiquidity; they are not suitable for retail investors seeking liquidity or regular income.

Return profile: AIF returns are typically realized through exits (IPO, strategic sale, secondary sale, buyback) rather than periodic distributions; the distribution waterfall (preferred return, catch-up, carry) determines how proceeds are shared between investors and the manager.

Fees: management fee (typically 1.5-2.5% p.a. of committed or invested capital) and performance fee/carry (typically 15-20% of profits above a hurdle rate); a hurdle rate of 8-10% is common, and fees must be fully disclosed in the PPM.

Conflicts of interest: the manager's carry creates an incentive for risk-taking; investors should review co-investment policies, related-party transactions and allocation policies; SEBI requires disclosure of conflicts and a conflict-of-interest policy.

Due diligence: review track record, team experience, investment strategy, portfolio concentration, valuation policy, exit history, fee structure and alignment of interest (manager commitment) before investing; check SEBI registration status and scheme-level disclosures.

SEBI has amended AIF regulations periodically; key changes include tightening of the definition of 'sponsor' and 'manager', clarification of continuing interest, and rules on tenure extension and liquidation period (with a maximum liquidation period after scheme expiry).

Category I and II AIFs must dematerialise their units; SEBI mandates that units be issued in demat form, and transfers must be recorded in the depository system; this improves transparency and transferability.

SEBI introduced norms for 'accredited investors' - a class of investors meeting specified income/net-worth thresholds who can access certain relaxations; distributors must verify accreditation and maintain records.

SEBI's AIF regulations require that the PPM and all material documents be filed with SEBI and made available to investors; any change to the PPM requires SEBI approval in specified cases.

Distribution conduct: distributors must not make false or misleading claims, must disclose all commissions, must not guarantee returns, and must ensure the product is suitable for the investor; mis-selling can attract SEBI action.

SEBI's code of conduct for intermediaries requires fair dealing, confidentiality, avoidance of conflicts, and maintenance of records; distributors must also comply with the SEBI (Intermediaries) Regulations, 2008.

Taxation: Category I and II AIFs have pass-through status for income other than business income; gains are taxed in investors' hands based on the nature of income; GST applies to management fees, and TDS obligations rest with the AIF/manager.

Investor protection: SEBI has a dispute resolution mechanism and an AIF industry standards forum; investors can approach SEBI SCORES; the AIF must disclose grievance redressal and comply with the SEBI (Investor Protection and Education Fund) norms where applicable.