AIF Category II: Your Gateway to Smarter Portfolio Growth

What are Category II AIFs?

Category II Alternative Investment Funds (AIFs) in India are SEBI-regulated investment vehicles that invest mainly in unlisted equity, private equity, real estate and debt instruments often targeting companies with strong fundamentals for growth and restructuring. 

They typically operate as close-ended funds with a minimum tenure of 3 years, which can be extended further.  

AIF Category II funds are typically targeted towards sophisticated investors, including institutional investors, high net worthindividuals (HNIs), and corporate investors. 

 How are Category II funds different from Category I funds? 

While Category I AIFs invest mainly in early stage ventures such as startups and SME’s, Category II invests in later stages of a company such as broader asset classes including private equity, debt funds, real estate, and distressed assets.

 In terms of risk and return, Cat I AIFs have higher risk and potential return compared to Cat II funds which offer moderate risk and more predictable returns. 

 One of the most noteworthy distinctions between Cat I and Cat II, is the provision of government support and incentives:

• Cat I AIFs gain recognition and promotion by the government due to its role in driving innovation and impact across startups, SMEs, and social ventures. They directly benefit from government-backed schemes, funding initiatives and  tax concessions aimed at encouraging investments. 
• Cat II AIFs operate without direct government incentives or support, relying mainly on private capital. Their regulatory framework remains neutral, unlike Cat I AIFs, that are actively promoted and incentivized by policies. 

 Expanding Beyond Traditional Assets 

The Strategic exposure offered by CAT II AIFS:

• Private Equity funds offer capital infusion into unlisted growth-stage companies, buyouts, and expansions, providing access to high-growth, pre-IPO opportunities. 

• Debt funds offer investments in corporate bonds, NCDs and structured credit instruments, which is yield-focused with lower volatility compared to equity. 

• Real Estate funds offer equity or debt financing for commercial/ residential projects with a diversified exposure to India’s real estate landscape. 

• Distressed Asset funds offer acquisition and turnaround of stressed companies or assets that have deep value plays with asymmetric return potential. 

• Fund of funds (FoF) offer allocation across other AIFs with varied strategies with a built in diversification and fund manager. 

Significance in Modern Investing 

Category II AIFs serve as a vital tool in modern investing by unlocking exclusive, diversified, and high-growth investment opportunities for investors who are willing to commit their capital over a longer time frame. 

• Access to alternative asset classes:

Category II AIFs invest in a broad range of asset classes that go beyond traditional public equity and mutual funds. This gives investors exposure to high-growth opportunities, which is unavailable in public markets. 

• Portfolio Diversification:

It gives investors a diversified portfolio across various assets, which reduces reliance on traditional stocks or bonds, indirectly lowering overall portfolio volatility. They offer solutions to balance risk with assets that may function differently across economic cycles. 

• Potential for higher long- term returns: 

Category II AIFs have the potential to outperform traditional investments over the long term due to the fact that they direct capital towards private businesses and niche opportunities, which is particularly suited for investors with a longer time horizon and higher risk tolerance. 

Professional Management for AIF CAT II funds:

Category II AIFs in India are professionally managed by investment vehicles regulated by the SEBI, which are designed to tap into private market opportunities with a structured and strategic approach.

Cat II funds rely heavily on professional managers to provide strategic allocation of capital, operational oversight, and risk management which is extremely crucial for successful investing in complex private market assets.

The expertise of professional managers helps in navigating investments across private equity, debt, real estate and distressed assets within the framework established by SEBI. 

Frequent valuations and transparent reporting is made mandatory by the SEBI which helps to maintain investor confidence and ensure governance discipline.

According to the SEBI, fund managers or sponsors are required to have a stake, contributing at least 2.5% of the funds corpus or ₹5 crore, whichever is lower, aligning their interests with those of investors. 

Core SEBI regulations for Category II AIFs: 

1. Investment Mandate: Cat II AIFs must invest primarily in unlisted securities which are defined as at least 50% of investible funds. They can also invest in units of other Cat I or Cat II AIFs, subject to disclosures in the placement memorandum.

2. Leverage Restrictions: CAT II AIFs cannot undertake any leverage, except for hedging purposes. This ensures risk containment and regulatory clarity. 

3. Disclosure and governance: The memorandums must clearly outline investment strategy, risk factors, and governance mechanisms. SEBI mandates periodic reporting to investors and the regulator, including both portfolio composition and valuation updates.

4. Regulation 17(a) update: The update clarifies that “primarily” means >50% of allocation to unlisted investments, removing unlisted lack of clarity from earlier drafts, strengthening alignment with SEBI’s push for transparency and market integrity. 

Recent amendments as of 2025

SEBI now allows Category II AIFs to invest in listed debt securities rated “A” or below, treating them as equivalent to unlisted securities for compliance purposes. The change addresses the shrinking pool of unlisted debt due to LODR amendments mandating listing of NCDs. 

Is AIF Category II right for your portfolio? 

A Category II AIF investment is the perfect fit for you, if you’re a sophisticated investor seeking diversified exposure to private equity, debt, and alternative assets while aiming for medium to long-term wealth growth.  

It is suitable for those who have the financial capacity to commit a minimum of ₹1 crore and the discipline to stay invested through lock-in periods typically spanning 3 to 7 years. 

However, if you require liquidity in the short term or prefer lower risk, a Cat II AIF may not be the best fit.

By carefully assessing risk tolerance, investment horizon, and conducting thorough due diligence, one can invest in Cat II funds andharness the benefits of professional management and portfolio diversificationwithout compromising your broader financial goals.