Why AIFs need regulatory innovation for next phase of growth

For sophisticated investors, AIFs have become an increasingly important part of their portfolio. As of January 2025, 1,485 AIFs were registered with the Securities and Exchange Board of India (Sebi). However, as the sector grows, the regulatory environment governing AIFs must evolve to not just keep pace with this rapid expansion but also adapt to global trends.

Balancing act

AIFs have thrived under Sebi’s relatively “light-touch” approach. This regulatory style has allowed new products and ideas to blossom, encouraging fund managers to innovate and explore diverse investment opportunities. 

However, as the sector matures, the regulator faces a familiar dilemma: How to strike the right balance between nurturing growth and imposing necessary guardrails. The perspective of regulation has to continue to prioritize flexibility to foster innovation. Regulating the fund rather than the investment manager could inadvertently turn into a rigid framework, stifling the very entrepreneurial spirit that has propelled the industry forward.

A more adaptive approach, allowing fund managers to explore emerging sectors like climate tech, biotechnology, and blockchain, would keep India’s AIF industry on the cutting edge of global trends.

For example, the UK has introduced tax incentives for green technology investments, supporting innovation and capital flow in critical industries. India could similarly incentivize AIFs that target high-growth, high-risk sectors, ensuring that capital is directed towards areas with transformative potential.

Tax clarity

One of the primary challenges facing AIFs, particularly Category III funds, is the ambiguity surrounding taxation. Category III AIFs, structured as trusts, are subject to complex tax rules, and their classification as “determinate” or “indeterminate” affects their tax treatment. Open-ended funds, which allow investors to enter and exit freely, are especially vulnerable to these ambiguities. 

Also Read: Managing market volatility: How AIFs turn risk into opportunity

To promote long-term growth, India must adopt a clearer pass-through taxation regime for AIFs, similar to mutual funds. Ensuring that Category III AIFs are taxed at appropriate capital gains rates would provide much-needed certainty for investors, preventing the risk of double taxation and simplifying tax compliance. The US private equity market, for example, benefits from a clear, investor-friendly tax framework that encourages capital gains to flow efficiently to investors. A similar structure for AIFs in India would make the sector more competitive and investor-friendly.

Cross-border investments

Global investors are increasingly drawn to India’s private capital ecosystem, but regulatory hurdles often impede cross-border investments. Simplifying the registration process for foreign investors, reducing compliance burdens, and aligning India’s AIF regulations with international standards would enhance global participation. The repatriation of capital should also be made more seamless to attract long-term international commitments.

Incentivizing long-term capital

To ensure a steady flow of capital into AIFs, especially during times of economic uncertainty, it is essential to incentivize long-term investments. Tax breaks for investors who commit capital for extended periods (e.g., five to ten years) would provide stability and allow fund managers to plan for sustained growth. Reducing compliance burdens for long-term investors could further bolster confidence in AIFs.

Conclusion

India’s AIF sector is at a critical juncture—much like the mutual fund industry during its formative years. The regulatory and tax reforms that were introduced then helped catalyze mutual funds’ exponential growth. Today, the AIF sector requires a similar approach—one that recognizes the sector’s unique role in the economy and fosters an environment for sustainable growth. A one-size-fits-all regulatory framework for AIFs is impractical, given the sector’s diversity. A Category I fund investing in social infrastructure should not be treated the same as a high-growth private equity fund, a low-volatility credit fund, or a hedge fund. Instead, a differentiated regulatory approach tailored to each fund’s unique investment mandate will ensure India’s AIFs continue to thrive.

Views are personal. 

Vikaas M. Sachdeva is managing director of Sundaram Alternate Assets