Short answer: An alternative investment fund (AIF) is a privately pooled vehicle that gathers money from investors and puts it into non-traditional assets such as private equity, venture capital and hedge funds. The Securities and Exchange Board of India (SEBI) divides AIFs into three categories, Category I, Category II and Category III, based on their investment strategies.
Last reviewed: 13 November 2026
At a glance
| Category | What it invests in | Examples named in SEBI’s classification |
|---|---|---|
| Category I | Startups, SMEs, infrastructure, social ventures and other sectors the government considers socially or economically desirable | Venture capital, angel, SME, infrastructure and social venture funds |
| Category II | Debt and equity of private companies, without leverage beyond day-to-day operational needs | Private equity, debt and funds of funds |
| Category III | Uses complex trading strategies, including derivatives, short-selling and leverage, to try to maximise returns | Hedge funds and PIPE funds |
| PIPE fund | Shares of publicly traded companies, typically bought at a discounted price | A type of Category III fund |
What does “privately pooled” mean?
A pooled fund combines money from many investors into one portfolio, and a fund manager decides where that money goes. “Privately” means the fund is not offered to the public through a stock exchange in the way listed shares are. Investors buy into the fund itself, not into individual companies.
The assets an AIF holds are also different from the usual listed shares and bonds. Private equity means buying stakes in companies that are not listed on a stock exchange. Venture capital means funding young companies, often at an early stage. Hedge funds are pooled funds that use a range of trading strategies.
Why does SEBI sort AIFs into categories?
SEBI sorts AIFs by what they do with the money, not by size or by the investor’s name. The category tells you the broad strategy the fund follows. Each category carries a different set of assets and a different level of trading complexity.
Reading the category is the first step in understanding a fund’s risks. The category does not tell you how well a particular fund has performed or will perform.
What does Category I invest in?
Category I AIFs put money into startups, small and medium enterprises (SMEs), infrastructure, social ventures and other sectors that the government considers socially or economically desirable. This category includes venture capital funds, angel funds, SME funds, infrastructure funds and social venture funds.
The common thread is that these are areas where money is needed to start or build something, often before the business has a track record. A startup may not yet have steady revenue, so the value of the investment can change sharply and may be lost entirely.
What does Category II invest in?
Category II AIFs invest in the debt and equity of private companies. Debt means lending money that must be repaid with interest, and equity means owning a share of the company. This category includes private equity funds, debt funds and funds of funds, which are funds that invest in other funds.
A key feature is that Category II funds do not use leverage beyond what they need to cover day-to-day operations. Leverage means borrowing money to invest more than the fund’s own capital. Without it, a loss is limited to the money the fund actually put in.
What does Category III do differently?
Category III AIFs use complex trading strategies to try to maximise returns. These strategies can include derivatives, which are contracts whose value depends on an underlying asset such as a share or an index. They can also include short-selling, which means betting that a price will fall, and leverage, which means borrowing to increase the size of the bets. Hedge funds and PIPE funds fall in this category.
Leverage magnifies both gains and losses. Consider this hypothetical example, with figures invented only for illustration. A fund has ₹10 crore from investors and borrows another ₹10 crore, so it invests ₹20 crore. If the investments fall 20 per cent, the fund loses ₹4 crore. That is 40 per cent of investors’ ₹10 crore, even though the underlying investments fell only 20 per cent.
What is a PIPE fund?
A PIPE fund, short for private investment in public equity, invests in shares of companies that are publicly traded. Those are companies whose shares are listed on a stock exchange. The fund typically buys these shares at a discounted price, meaning less than the prevailing market price.
A discount sounds attractive, but it has a catch. Suppose a listed company’s share trades at ₹200, and a PIPE fund buys it at ₹180. That is a 10 per cent discount, shown here as a hypothetical example. If the share price then falls to ₹150, the fund’s position is worth less than what it paid, so the discount does not protect against a fall in the price.
What are the main risks?
The first risk is that AIFs are privately pooled, so investors usually cannot see the holdings or prices as easily as they can with listed shares. The second is that Category I funds often back young or early-stage businesses, where losses are common. The third is that Category III funds can use borrowing and short-selling, which can turn a modest market move into a large loss.
Across all categories, the fund’s value depends on the decisions of its manager and on conditions in the assets it holds. Reading the category, the strategy and the way the fund uses leverage is a starting point for understanding the risks involved.
Frequently asked questions
Which AIF category invests in startups?
Category I AIFs invest in startups, along with SMEs, infrastructure and social ventures. This category includes venture capital and angel funds.
Which category uses borrowed money to invest?
Category III AIFs use leverage as part of complex trading strategies. Category II AIFs do not use leverage beyond what they need for day-to-day operations.
What is a PIPE fund?
A PIPE fund invests in shares of publicly traded companies, typically buying them at a discounted price. It falls under Category III.
Does SEBI classify AIFs by their investment strategy?
Yes. SEBI divides AIFs into Category I, II and III based on their investment strategies.
Sources and last check
Facts in this article were checked against the sources below on 13 November 2026. Rules and figures can change; check the primary source before acting.
- upstox.com (broker education)
- groww.in (broker education)
- kotakneo.com (broker education)
This article is general information, not investment advice. MyFinanceBandhu is not a SEBI-registered investment adviser.