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Why do investors prefer category 3 AIFs to diversify portfolios? MintGenie explains


In the fast-paced world of financial markets, it is clear that the stock market tends to have erratic price movements due to geopolitical situations, global headwinds, and more. While there can be many reasons for these movements, they ultimately affect investors’ portfolios. Therefore, in this case, the relevance of diversification cannot be overstated. In an era where the pursuit of diversified portfolios and maximum returns is at the fore, investors are constantly looking for ways to strengthen their investment strategies.

Alternative investment funds (AIF) in this context they have emerged as a preferred asset class among investors seeking to provide diversification. Among the three types of AIFs, category 3 has gained significant traction over the years. This is due to its various advantages, such as high yield and long investment horizon, and mainly due to its ability to provide significant diversification.

Diversification with impact: The impact of category 3 AIFs

In the field of investment, the adage “Don’t put all your eggs in one basket” is very accurate. Diversification is therefore a vital risk reduction measure, and AIFs provide access to a wider variety of assets than just ordinary securities and fixed income stocks. Alternative investment funds offer additional options, many of which have the potential to diversify and increase returns on investment. These investment vehicles, in contrast to ordinary shares, bonds, and mutual fundsproviding investors with fresh and innovative approaches to maximizing their wealth.

According to SEBI, the AIF industry grew by 30% in FY 2022-2023 and increased from Rs. 6.41 lakh crore from the previous year to Rs. 8.34 lakh crore in March 2023. Category 3 AIFs have specifically driven some improvements. These investment vehicles generally focus on growth-oriented companies, including large, mid-cap and small-cap companies, and are prominent the results they were providing.

According to a report by PMBSBazaardespite the market corrections, 60 out of 61 category 3 AIFs outperformed Nifty 50 in August 2023. This shows that, rather than acting as a cushion against market volatility or financial crisisthese funds have the potential to deliver strong returns.

While AIF category 3 can be a strategic move for investors looking to diversify beyond traditional channels, choosing the right fund can make a big difference to the portfolio.

Choosing the right AIF

The first most important criteria for selection is that the AIF must be managed by an AMC (asset management company) with an exceptional track record of serving HNIs, family offices and more. Explore the firm’s investment philosophy and carefully examine whether it is aligned with your investment goals and risk tolerance. The investment criteria can have different parameters, such as investing in value-oriented growth companies, buying at a discount to intrinsic value, avoiding highly leveraged companies, avoiding frequent equity dilution, and more.

The historical performance of the fund needs to be critically analyzed and compared with the benchmark indices to get a better insight. In addition, CRISIL has launched category-wise benchmarks for AIFs, which will help you make further investment decisions based on comparative data.

AIFs: A viable option to create a diversified portfolio!

It cannot be denied that we live in a world where the field of investments is changing, and Category 3 AIFs are at the forefront of this change. Their ability to diversify portfolios, increase returns, and provide exposure to specific asset classes make them an attractive option for investors looking to maximize their wealth.

Investors, however, need to do extensive due diligence, determine their risk tolerance, and align those investments with their financial goals in order to choose the right AIF for their investments. As a result, with the right methodology and a thorough understanding of these alternative assets, investors can use Category 3 AIFs to create a well-balanced, diversified portfolio.

Aman Soni, Head of operations at Prudent Equity

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Updated: 01 November 2023, 10:56 AM IST

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