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Business News/ Money / Personal Finance/  Why do investors prefer category 3 AIFs to diversify portfolios? MintGenie explains
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Why do investors prefer category 3 AIFs to diversify portfolios? MintGenie explains

Category 3 alternative investment funds (AIFs) have become popular among investors seeking diversification due to their potential for high returns and long investment horizons.

AIFs are growing as a preferred asset class among investors seeking portfolio diversification. Premium
AIFs are growing as a preferred asset class among investors seeking portfolio diversification.

In the fast-paced world of financial markets, it is evident that the stock market tends to experience erratic price movements due to geopolitical situations, global headwinds, and more. While the reasons for these movements can be many, they end up impacting the portfolios of investors. Therefore, in this scenario, the relevance of diversification cannot be overstated. In an era where the pursuit of diversified portfolios and maximum returns reign supreme, investors are constantly seeking avenues to bolster their investment strategies.

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

Diversification with impact: The influence of category 3 AIFs

In the realm of investing, the adage "Don't put all your eggs in one basket" is very accurate. Thus, diversification is a vital risk-reduction tactic, and AIFs provide access to a wider variety of assets than only conventional fixed-income securities and stocks. Alternative investment funds offer more options, with many of them having the capacity to diversify and boost returns on investment. These investment vehicles, in contrast to conventional equities, bonds, and mutual funds, provide investors with fresh and innovative approaches to maximising their wealth. 

According to SEBI, the AIF industry experienced 30% annual growth in FY 2022–2023 and surged from Rs. 6.41 lakh crore from the previous year to Rs. 8.34 lakh crore in March 2023. Category 3 AIFs specifically have prompted a number of improvements. These investment vehicles generally focus on growth-oriented companies, including large, mid, and small-cap companies, and the results they have been providing are remarkable. 

According to a report by PMSBazaar, despite the market corrections, 60 out of 61 category 3 AIFs outperformed Nifty 50 in August 2023. This showcases that, apart from acting as a cushion in market volatility or a financial crisis, these funds have the potential to deliver robust returns.

While AIF category 3 can be a strategic move for investors seeking diversification beyond traditional avenues, selecting the right fund can make a huge difference in the portfolio.

Choosing the right AIF

The first and foremost standard for selection is that the AIF must be managed by a reputed AMC (asset management company) with an exceptional track record in serving HNIs, family offices, and more. Explore the investment philosophy of the firm and carefully examine if it aligns 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, eluding frequent equity dilution, and more. 

The historical performance of the fund must be critically analysed and compared with the benchmark indices for a better view. Moreover, CRISIL has also launched category-wise benchmarks for AIFs, which will further help you make better investment decisions based on comparative data.

AIFs: A viable option to create a diversified portfolio!

There is no denying the fact that we are living in a world where the realm of investments is evolving, and Category 3 AIFs are at the forefront of this shift. Their ability to diversify portfolios, boost returns, and provide exposure to distinct asset classes makes them an appealing option for investors looking to maximise their wealth. 

Investors must, however, undertake extensive due diligence, determine their risk tolerance, and align these investments with their financial goals to choose the right AIF for their investments. As a result, with the correct methodology and a thorough understanding of these alternative assets, investors can use Category 3 AIFs to build a well-rounded, diversified portfolio.

Aman Soni, Head of operations at Prudent Equity

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Updated: 01 Nov 2023, 10:56 AM IST
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