Table of Contents

• Introduction
• The Purpose: Aligning Strategy with Goals
• SEBI Categories & Tax Implications
• The Selection Process
• Entering at the Right Stage of the Cycle
• Mapping Funds to Investor Profiles
• The Carnelian Perspective on Amritkaal
• FAQs

Introduction

For most high net worth investors, the decision to diversify into private markets has already been made. The challenge now lies in the selection process. As the variety of available strategies expands, the level of due diligence required becomes more intense. And the right choice depends on identifying a fund manager whose philosophy aligns with your long term objectives. It requires a clear understanding of how different categories function under the current SEBI framework and how they interact with your existing holdings.

This guide provides a clear approach to evaluating these vehicles to ensure your capital is placed with the most capable managers.

The Purpose: Aligning Strategy with Goals

The primary reason to include an AIF in a portfolio is the ability to access institutional grade opportunities that are unavailable in public markets. These funds allow you to participate in the growth of companies during their most productive stages of scaling. By accepting a lock in period, you provide the fund manager with the stable capital needed to implement long term value creation strategies.

In the current Indian economic environment, this often means focusing on sectors like specialized manufacturing or tech enabled services. The focus is on the illiquidity premium, which is the additional return expected for committing capital over a five to seven year horizon.

SEBI Categories & Tax Implications

SEBI divides AIFs into three distinct categories. Choosing the right one is as much a tax decision as it is an investment one.

Feature	Category I	Category II	Category III
Primary Focus	Venture Capital, SME, Social Ventures	Private Equity, Real Estate, Debt Funds	Hedge Funds, Long-Short, PIPE
Tax Status	Pass-through (Taxed at your slab)	Pass-through (Taxed at your slab)	Fund-level tax (Max Marginal Rate)
Structure	Closed-ended	Closed-ended	Open or Closed-ended
Leverage	Not allowed for investment	Not allowed for investment	Allowed within SEBI limits

Category I and II are generally more tax efficient for individual investors because the fund does not pay tax on capital gains. The tax liability passes through to you, which means you pay the applicable capital gains rate only when the fund realises a profit.

Category III funds are taxed at the fund level as a representative assessee, which is simpler for paperwork but often results in a higher effective tax rate.

The Selection Process

When you commit capital to an AIF, you are backing a team and their specific philosophy. Use these markers to filter your options:

• Fund Vintage: It is useful to compare funds that started in the same year. This allows you to see how different managers handled the specific economic challenges of that period.
• Hurdle Rates and Catch-up Clauses: Look for a preferred return or hurdle rate. This ensures the manager only earns a performance fee after you have received a minimum return, typically 8% to 10%.
• Skin in the Game: High sponsor commitment is a vital indicator of confidence. When the fund management team invests their own wealth into the same units you hold, their interests are naturally aligned with yours.
• DPI (Distribution to Paid-In Capital): While IRR shows the potential growth of your investment, DPI measures the actual cash returned to you. For a seasoned fund, a rising DPI is a sign of successful exits and realized gains.

Entering at the Right Stage of the Cycle

AIFs often have a lifespan of 7 to 10 years. Since these are long-term commitments, you should look for Growth Themes that are just beginning to unfold.

For instance, in 2026, the focus has moved toward India’s Amritkaal, the period leading up to 2047. If the macro environment shows a steady decline in inflation and a push for domestic manufacturing (PLI schemes), it is an opportune time to enter Category II Private Equity funds that focus on mid-market manufacturing. Conversely, if you expect high market volatility, a Category III Long-Short fund might be better suited to protect your capital.

Mapping Funds to Investor Profiles

• Growth Oriented Portfolios: For those with a long term horizon, Category II Private Equity funds targeting mid-market leaders offer high growth potential. These are suitable for investors who do not require immediate liquidity.

• Income Oriented Portfolios: Category II Debt funds provide an alternative to traditional fixed income. These funds invest in structured credit or venture debt, offering higher yields in exchange for taking on private credit risk.

• Tactical Portfolios: Category III funds are appropriate for investors who want a manager to trade across equities actively and derivatives (not mandatory). These structures can often be open-ended, providing more flexibility for entry and exit.

The Carnelian Perspective on Amritkaal

At Carnelian, we focus on identifying quality businesses, quality management that are growing but available at a reasonable valuation. Our approach is built on the belief that India’s economic trajectory over the next two decades offers a generational wealth-creation opportunity.

If you are looking for a strategy that is a Flexi-cap portfolio that captures long-term trends across five mega sectors — BFSI, Manufacturing, Consumption, Services Export, and Infrastructure over Amritkaal period (22 years period leading to India’s 100-year celebration in 2047), our Carnelian Bharat Amritkaal Fund is designed for that exact purpose. It targets companies that are poised to be the leaders of a developed India.

Explore the Carnelian Bharat Amritkaal Fund or contact our team of experts today.

FAQs

1. How does the lock in period work for Category II AIFs?
   Most Category II funds have a tenure of 5 to 7 years, with a possible extension of 2 years. During this time, your capital is called in stages as the manager finds investment opportunities. You cannot withdraw your money early, but you will receive distributions as the manager exits individual portfolio companies.

2. What are the key risks specific to AIFs?
   The primary risks include illiquidity, as there is no active secondary market for these units, and concentration risk. Unlike retail products, AIFs take larger bets on fewer companies. There is also the risk associated with unlisted valuations, which are updated periodically rather than daily.

3. What happens if the fund tenure ends but the manager hasn’t sold all the companies?
   SEBI has introduced a ‘Liquidation Scheme’ framework. If a fund cannot exit certain investments by the end of its tenure, it can transfer those assets to a new liquidation scheme with the consent of 75% of investors, or it can distribute the “in-specie” assets directly to your demat account.

4. Are there any hidden costs in an AIF structure?
   Beyond the management and performance fees, there are operating expenses such as audit fees, legal costs, and valuation charges. SEBI has capped these expenses for certain funds, but it is important to check the Private Placement Memorandum (PPM) for the specific expense ratio.

5. How does the side-pocketing rule work in an AIF?
   If a specific investment in the fund portfolio turns into a stressed asset or defaults, SEBI allows the manager to side-pocket that particular asset. This separates the bad asset from the healthy ones, allowing you to redeem or track the rest of the portfolio without being held back by one problematic investment.

6. Can an HNI invest in an AIF through a family trust?
   Yes, family trusts are common vehicles for AIF investments. As long as the trust meets the eligibility criteria and the minimum investment of ₹1 crore, it can be the registered investor. This is often used for succession planning and long term wealth transfer.