Professional Documents
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Alternative Investments New
Alternative Investments New
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Alternative Investments??????
"Alternative investments" collectively refers
to the many asset classes that fall outside the
traditional definitions of stocks and bonds.
This category includes hedge funds.
Private equity, real estate ,commodities ,
and other alternative investments,
primarily collectibles.
Each of these alternative investments has
unique characteristics that require a different
approach by the analyst
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Alternativeinvestments differ from traditional
investments (publicly traded stocks,bonds,
cash) both
◦ in the types of assets and securities included in
this asset class and
◦ in the structure of the investment vehicles in
which these assets are held.
Managers of alternative investment portfolios
may use derivatives and leverage, invest in
illiquid assets, and short securities.
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Fee structures for alternative
investments arc different than those of
traditional investment with higher
management fee on average and often
with additional incentive fees based on
performance.
Alternative investments as a group have
had low returns correlations with
traditional investments
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Characteristics of Alternate Investments
Less liquidity of assets held.
More specialization by investment
managers.
Less regulation and transparency.
More problematic and less available
historical return and volatility data.
Different legal issues and tax treatments,
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Global Assets Under Management
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Global Assets Under Management
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Investors Considering Alternative
Investments as a tool
The 2019 annual report for the Yale University endowment
provides one institutional investor’s reasoning behind the
attractiveness of investing in alternatives:
◦ The heavy [75.2%] allocation to nontraditional asset classes
stems from the diversifying power they provide to the portfolio
as a whole.
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Alternative investments -Portfolio
management.
Risk-return characteristics.
Despite unique risks and considerations, alternative
investments can be useful tools to improve the risk-
return characteristics of an investment portfolio.
They can increase diversification and reduce volatility,
given low correlations to more traditional investments;
they can offer the potential for enhanced returns due to
the wider investment opportunity set; and they can
hedge certain portfolio exposures, thereby reducing
concentration risk.
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This graph illustrates a sample Markowitz
efficient frontier, representing all portfolios with
the lowest risk (as measured by volatility) for a
given level of return, or conversely all portfolios
with the highest return for a given level of risk.
The inclusion of alternative investments can
move the efficient frontier up and to the left, so
for a given level of return, risk is lower, or for
a given level of risk, return is higher.
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Diversification.
While alternative investments on their own may have higher
volatility than more traditional investments, particularly fixed
income, they typically have low correlations to more traditional asset
classes. As such, their inclusion in an investment portfolio tends to
result in lower overall volatility.
Return.
Because they have a wider universe in which to invest and do not
have some of the same investment constraints (can short and hedge),
alternative investments have the potential for higher performance
than traditional investments.
The reasons for these higher returns can further be thought to be that
some alternative investments are less efficiently priced than
traditional assets (providing opportunities for skilled managers).
that alternative investments often use leverage.
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INVESTMENT METHODS
The three methods of investing in
alternative investments:
◦ direct investing,
◦ co-investing, and
◦ fund investing
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Fund Investing
In fund investing, the investor contributes capital to a fund, and
the fund identifies, selects, and makes investments on the
investor’s behalf.
For the fund’s services, the investor is charged a fee based on the
amount of the assets being managed, and a performance fee is
applied if the fund manager delivers superior results.
Fund investing can be viewed as an indirect method of investing
in alternative assets.
Note that fund investing is available for all major alternative
investment types, including hedge funds, private capital, real
estate, infrastructure, and natural resources.
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The primary advantage of fund investing include the
professional services offered by fund managers, a lower
level of investor involvement (compared with the direct
and co-investing methods), and access to alternative
investments without the prerequisite of advanced
expertise.
Fund investing in alternative investments is costly
because the investor is required to pay management fees
and performance fees that are typically higher than fees
for traditional asset classes.
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Co-Investing
In co-investing, the investor invests in assets indirectly through the
fund but also possesses rights (known as co-investment rights) to
invest directly in the same assets.
Through co-investing,an investor is able to make an investment
alongside a fund when the fund identifies deals;
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Co-investors, who are essentially engaging in a hybrid of direct
investing and fund investing, can learn from the fund’s process and
leverage the experience they gain to become better at direct
investing. Many institutional investors begin with fund investing,
because it provides instant diversification while requiring less
costly minimum participation levels (lower minimums) and less due
diligence.
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Direct investing
Direct investing occurs when an investor makes a direct
investment in an asset (labeled “Investment A”) without the use of
an intermediary. In private equity, this may mean the investor
purchases a direct stake in a private company without the use of a
special vehicle, such as a fund.
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Direct investing allows the investor to build a portfolio of
investments to her exact requirements.
Direct investing provides the greatest amount of flexibility for the
investor and grants the highest level of control over how the asset is
managed.
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Overview of different types of investments
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Hedge Funds
These funds may use leverage, hold long
and short positions, use derivatives, and
invest in illiquid assets.
Managers of hedge funds use a great
many different strategies in attempting to
generate investment gains. They do not
necessarily hedge risk as the name might
imply.
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Private Equity Funds
As the name suggests, private equity fund invest in the
equity of companies that are not publicly traded or in
the equity of publicly traded firm that the fund intends to
take private.
Leveraged buyout (LBO) funds use borrowed money to
purchase equity in established companies and comprise the
majority of private equity investment funds.
A much smaller portion of these funds,venture capital
funds invest in or finance young unproven companies at
various stages early in their existence.
There can also be investment in distressed company,
which might be another investment strategy used by hedge
funds as well.
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Real Estate
Real estate investments include residential or
commercial properties as well as real estate
backed debt.
These investments are held in a variety of
Structures including full or leveraged ownership
of individual properties, individual real estate
backed loans, private and publicly traded
securities backed by pools of properties or
mortgages, and limited partnerships.
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Commodities
To gain exposure to changes in commodities
prices, investors can own physical commodities,
commodities derivatives, or the equity of
commodity producing firms.
Some funds seek exposure to the returns on
various commodity indices,often by holding
derivatives contracts that are expected to track a
specific commodity index,
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Other
This category includes investment in
tangible collectible assets such as fine
wines, stamps, automobiles, antique
furniture, and art, as well as patents, an
intangible asset.
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Investment cycle
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Expected investment attributes for core
alternative investment asset classes
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Key moments in the history of alternative
investments
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Laying the foundations for alternative
investments
Regulatory changes
US Small Business Investment Act of 1958:
The law supported private investment in small businesses and innovation.
US Department of Labor update (1978) to the Employee
Retirement Income Security Act of 1974 (ERISA):
◦ This update lifted an earlier restriction placed on pension funds from investing in
privately held securities, thereby enabling them to invest in alternative
investments.
Economic Recovery Tax Act of 1981:
◦ The law reduced capital gains taxes, which increased the attractiveness of equity
investments relative to debt. As a result, institutional investors, such as pension
funds, increased their allocation to alternative investments.
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Technological change
The technology revolution, in part funded by alternative investors
(venture capital), and innovative ideas by academics also played a
pivotal role in the history of alternative investments.
Black-Scholes options pricing formula (1973) and the application
of the Gaussian copula theorems to financial instruments (2000)
enabled investors to quickly and easily price complex financial
products such as derivatives and structured securities, which
supported their rapid growth and increased liquidity in markets
overall.
Hedge funds benefited immensely from these changes, as their
business models often rely on the large and liquid markets and/or
accessing, analysing, and valuing large amounts of data or complex
financial instruments.
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Market Events
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Growth of core alternative asset
classes
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Growth in assets under management
by asset class
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AI v/s TI
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Investing in alternative investments
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TWRR vs MWRR
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Investment life cycle for different types of alternative
investors
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A word of Caution!!!!
While it seems that adding alternative investments to a portfolio
will improve both portfolio risk and expected return, choosing the
optimal portfolio allocation to alternative investments is complex
and there are potential problems with historical returns data and
traditional risk measures.
Survivorship Bias refers to the upward bias of returns if data only
for currently existing (surviving) firms is included. Since surviving
firms tend to be those that had better-than-average returns.
excluding the returns data for failed firms results in average returns
that are biased upward.
Backfill bias refers to bias introduced by including the previous
performance data for firms recently added to a benchmark index.
Since firms that are newly added to an index must be those that
have survived and done better than average including their returns
for prior years (without including the previous and current returns
for funds that have not been added to the index) tends to bias index
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Risks of Alternative Investments
Higher fees.
Alternative investments can have higher fees.
More complicated.
Alternative managers may invest in a wide variety of
investments. Understanding complicated investment strategies
requires more upfront and ongoing due diligence.
Less transparent.
There can be limited transparency into the underlying holdings
of these investments. Additionally, many manager evaluation
tools are not as well suited for alternative investments, making a
manager's investment ability more difficult to assess.
Less liquid.
The underlying investments used in an alternative investment
strategy may also be exposed to a significant lack of liquidity in
stressful trading environments.
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Background of AIFs in India
Till 2012 Investment Management regulations of SEBI were limited only
to Mutual Funds (MF),Collective Investment Schemes (CIS), Venture
Capital Funds (VCF) and Portfolio Managers, and were well regulated.
In the absence of dedicated regulations, other private pools of capital and
investment vehicles like PE Funds (Private Equity), Real Estate Funds, etc
used VCF route for investments.
It was felt to recognize such other funds as “Alternative Investment Funds”
as a distinct asset class apart from promoter holdings, creditors and public
investors.
Accordingly, SEBI has released a concept paper in August 2011 followed
by issuing SEBI (Alternative Investment Funds) Regulations (herein after
referred as ‘AIF Regulations’) in May 2012 and were amended time to time.
SEBI (Venture Capital Funds) Regulations, 1996 were repealed and
related provisions were subsumed in to AIF Regulations. However, SEBI
(Foreign Venture Capital Investor) Regulations are not subsumed and are
still governed separately
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AIF can be of different types like Angel Fund, PE Fund,
PIPE Fund, Venture Capital Fund, Debt Fund,
Infrastructure Equity Fund, Real Estate Fund, SME
Fund, Social Venture Fund and Strategy Fund (like
hedge fund).
AIFs float various schemes for investment based on risk
appetite of its investors / unit holders.
A person or persons who set up an AIF is called as
“Sponsor” and includes a promoter in case of a
company and designated partner in case of an LLP. A
Sponsor can also act as Manager subject to having
relevant expertise.
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Eligibility:
AIF can be formed as a company, trust, LLP or a body
corporate.
However, a family trust, an ESOP trust, an employee welfare
trust, funds managed by a securitization company under
SARFAESI Act or any other pool of funds which is directly
regulated by any other regulator in India, which have functions
like AIF, will not be considered as AIF.
Registration
No person or entity shall act as AIF unless it has obtained a
certificate of registration from SEBI. Any fund which is
already under existence by the time of commencement of AIF
Regulations, should get itself registered within six months
therefrom.
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Eligibility Criteria for AIF
Registration
MOA/Trust Deed/Partnership Deed permits carrying on the activity of
AIF
Trust Deed/Partnership Deed to be registered under respective
governing laws
MOA/Trust Deed/Partnership Deed to prohibit making an invitation to
the public to subscribe its securities
The Applicant, Sponsor and Manager are “fit and proper” based on the
criteria specified in Schedule II of the Securities and Exchange Board of
India (Intermediaries) Regulations, 2008
The key investment team of the investment manager of the AIF should
have adequate experience with at least 1 (one) key personnel having
not less than 5 years of relevant experience
Manager & Sponsor has the necessary infrastructure and manpower to
discharge its activities
The Applicant to clearly describe investment objective, investment
strategy, proposed corpus, tenure and target investors
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Process of registration
Self-registration on SEBI online portal and online
payment of Rs. 1 lakh application fee
On receipt of login and password, uploading of Form A
on SEBI portal along with final PPM and copy of
executed Trust Deed and requisite
declarations/undertakings
The entire registration process generally takes 2 to 3
months
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COSTS
Costs borne by the Fund
◦ 1. Set up Costs – initial documentation, registrations, legal,
taxation and advisory fee etc.
◦ 2. Marketing Fee – fee paid to distributors
◦ 3. Administration Costs – meetings of the fund committees, the
investors, reports, audit fees etc.
◦ 4. Management Fee – paid to the AMC for providing investment
advice to the AIF.
◦ 5. Investment & Transaction Costs - due diligence and
documentation costs.
Costs borne by the AMC
◦ 1. AMC employee costs.
◦ 2. Administration Costs – all costs other than those costs that are
specifically borne by the Fund
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ECONOMIC RETURNS
Returns (2 / 20 Model)
1. Management Fee
◦ a) During the Investment Period, management fee is paid as a
percentage of the capital commitments. After the Investment Period,
management fee is paid as a percentage of the cost of investments made
by the AIF.
◦ b) Paid to offset the costs of running the Fund and the AMC Team.
2. Carried Interest / Performance Fee
a) The AMC is paid a percentage of the profits made by the Fund,
over and above the hurdle rate – typically shared between the
employees and the sponsors of the AMC.
- Special class of units issued to persons entitled to earn carried
interest.
b) The entire carried interest is back-ended and paid after the initial
capital is distributed to the investors – also known as the waterfall
mechanism.
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AIF Regulations In India
Category I AIF are those AIFs with positive spillover effects on the
economy, for which certain incentives or concessions might be
considered by SEBI or Government of India;
Such funds generally invests in start-ups or early stage ventures or social
ventures or SMEs or infrastructure or other sectors or areas which the
government or regulators consider as socially or economically desirable.
They cannot engage in any leverage except for meeting temporary
funding requirements for not more than thirty days, on not more than
four occasions in a year and not more than ten percent of the
corpus.eg. Venture Capital Funds, SME Funds, Social Venture Funds
and Infrastructure Funds.
Giving effect to the announcement by Union Finance Minister on angel
investor pools in the Union Budget 2013-14, SEBI in June 2013 has
approved a framework for registration and regulation of angel pools under
a sub- category called 'Angel Funds' under Category I- Venture Capital
Funds. Such funds shall be close ended.
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AIF Regulations In India
Category II AIF are those AIFs for which no
specific incentives or concessions are given.
They do not undertake leverage or borrowing
other than to meet the permitted day to day
operational requirements, as is specified for
Category I AIFs. eg. Private Equity. Such funds
shall be close ended.
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AIF Regulations In India
Category III AIF are funds that are considered to have
some potential negative externalities in certain situations
and which undertake leverage to a great extent;
These funds trade with a view to make short term returns.
These funds are allowed to invest in Category I and II
AIFs also.
They receive no specific incentives or concessions from
the government or any other Regulator.eg. Hedge Funds
(which employs diverse or complex trading strategies
and invests and trades in securities having diverse
risks or complex products including listed and
unlisted derivatives).
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Once registered, an AIF cannot change its category
except with approval of SEBI. Only such AIF which has
not raised funds from investors can apply for change in
category, along with fresh application fee as mentioned
below.
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There shall be no registration fee for change in
category.
Tenure of Category I and II AIF, being close
ended, shall be minimum of three years. An
extension can be permitted up to 2 years subject
to approval of 2/3rd investors by value. In the
absence of such approval, AIF shall fully
liquidate itself within one year from end of
fund tenure or extended tenure
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Cumulative net figures as at the end of March, 2023
(All figures in Rs. Crores)
Category of AIF Commitments raised Funds raised Investments made
Category I
Infrastructure Fund 18,738.08 8,380.28 5,469.33
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General Investment Conditions and
Restrictions for AIF:
i. Each scheme of AIF shall have a corpus of at least INR 20 Cr
ii. Maximum number of investors per scheme shall be 1000,
subject to provisions of Companies Act governing members in case
AIF is a company
iii. Minimum value of investment by each investor shall be INR 1
Cr. In case of investors who are employees or directors of AIF or
its manager, the minimum value of investment shall be INR 25
Lacs.
iv. The manager or sponsor shall have a continuing interest of not
less than 2.5% or INR 5 Cr whichever is less.
◦ In case of Category III AIF, the same shall be 5% or 10 Cr respectively. And
this interest shall not be through waiver of their management fee.
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General Investment Conditions and
Restrictions for AIF:
v. An AIF shall not solicit or collect funds except by
way of private placement
vi. Category I and II AIF shall invest not more than
25% of its investible funds in one investee company. In
case of Category III AIF, it shall be not more than 10%
of its investible funds.
vii. Uninvested portion of AIF funds, if any, can be
invested in short term liquid assets of high quality like
treasury bills, commercial papers, etc till their
deployment as per investment objective
viii. The units of a close ended AIF may be listed on any
stock exchange subject to a minimum tradable lot of
INR 1 Cr
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Category Wise Additional Conditions
Category I AIF:
◦ i. It shall primarily invest in investee companies or venture
capital undertakings (VCU) as specified in AIF Regulations
◦ ii. It may invest in units of another Category I AIF of same sub-
category (like SME Fund, Infrastructure Fund, etc) but not in
units of Fund of Funds. This is considering the benefits that
may be available to Category I AIF.
◦ iii. It shall not borrow funds directly or indirectly or engage in
any leverage except for meeting temporary funding requirements
for not more than thirty days, on not more than four
occasions in a year and not more than 10% of the investible
funds.
◦ iv. Conditions specific to sub-category of Category I AIF are as
below:
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Category I AIF
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Examples of Social venture Funds
Firms such as Lok Capital, Aavishkaar Venture
Management, Elevar Equity and Menterra Venture
Advisors have been operating for a long time in India.
In 2012 SEBI classified social venture funds under
Category 1 AIF (alternative investment funds). Some
firms, which have launched a category 1 AIF social
venture fund are Ankur Capital, Unitus Ventures and
Planner India
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Examples of Infrastructure AIFs
Edelweiss Infrastructure Yield Plus, L&T
Infra Investment Partners and Piramal
Infrastructure Fund.
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Category II AIF
i. It shall invest primarily in unlisted investee companies.
ii. Unlike Category I AIF, Category II AIF may invest in units
of any Category I or Category II AIF, but not in units of other
Fund of Funds.
iii. It shall not borrow funds directly or indirectly or engage in
any leverage except for meeting temporary funding
requirements for not more than thirty days, on not more than
four occasions in a year and not more than 10% of the
investible funds.
iv. It may enter in to agreement with merchant banker for
subscribing under-subscribed portion of the issue or to receive
or deliver securities in the process of market making under
SEBI ICDR Regulations
v. It may engage in hedging subject to guidelines of SEBI
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Category II AIF
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Category III AIF
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Sector Wise Exposure
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ANGEL FUNDS
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vii. It shall invest in VCUs which comply with age criteria specified
by DIPP from time to time, which have a turnover of less than INR 5
Cr and which are not promoted or sponsored by or related to an
industrial group whose group turnover exceeds INR 300 Cr
viii. Its investment in any VCU shall not be less than INR 25 Lacs
and shall not exceed INR 5 Cr, and such investment shall be locked
in for a period of 1 year
ix. It shall not invest in associates
x. It shall not invest more than 25% of the total investments under all
its schemes in one VCU
xi. The Manger or Sponsor of angel fund shall have continuing
interest of not less than 2.5% or INR 50 Lacs whichever is lower, and
it shall not be through waiver of management fee.
xii. Units of angel fund shall not be listed on any stock exchange.
xiii. An Angel Fund is not permitted to invest in overseas companies
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Other Information – all AIFs
a. All AIFs shall have internal policies and procedures for conduct
of its business and shall review them on periodical basis to ensure
continued appropriateness.
b. If the corpus of AIF is more than INR 500 Cr, such AIF shall
appoint a custodian for safekeeping of its securities. In case of
Category III AIF, appointment of custodian is mandatory
irrespective of corpus size.
c. Any change in sponsor or manager shall be informed to SEBI.
Prior approval of SEBI is required in case of change in control of
AIF.
d. Sponsors and managers shall establish and implement policies
and procedures to ensure avoidance of conflict of interest, and
ensure such conflicts are resolved in the interest of investors
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e. All AIFs shall ensure transparency in the conduct of their business by
disclosing required information to investors on financial & risk
management, operations, legal actions, fee ascribed to Manager / Sponsor,
or any other material liability affecting AIF.
f. The manager and sponsor shall maintain records in respect of assets
under the scheme / fund, valuation policies and practices, investment
strategy, etc for a period of five years after the winding up of the scheme /
fund.
g. All AIFs shall file such reports as may be required by SEBI in respect of
its activities
h. SEBI may suo moto or up on receipt of compliant or information cause
inspection of books of account or any other record / document of AIF, and
such AIF shall cooperate with the inspecting authorities.
i. All AIFs shall strictly adhere to disclosure, operational, prudential and
reporting norms stipulated by SEBI time to time
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Cat 1 and Cat 2
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Cat 3
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Cat 3
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Trend in Category 1 AIF