CAT III AIFs grab half of new flows; industry calls for leverage, tax clarity to unleash next wave

The recent introduction of SIFs (Specialized Investment Funds) in the mutual fund space is raising fresh concerns about category overlap and investor confusion.

Category III AIFs are emerging as the engine of growth in India’s alternative investment space, drawing over 50 percent of all new capital that flowed into AIFs over the past year, according to the latest IVCA report. Notably, Cat III funds also accounted for 54 percent of the incremental NRI investments into AIFs, signalling a rising global appetite for India’s long-short and absolute return strategies.

Yet even as momentum builds, leading fund managers while speaking at the IVCA Cat III AIF Summit 2025 said that the full potential of Cat III AIFs remains untapped — constrained by regulatory caps on leverage, taxation ambiguity, and a lack of structural parity with other vehicles like SIFs and mutual funds.

“Despite Cat III AIFs having a regulatory standing for more than a decade, there’s not even a single tax chapter in the context of stocks over Cat III funds,” said Bhautik Ambani, CEO of AlphaGreP Investment Management. “We’re working with both the capital markets regulator and the Finance Ministry to solve for both parity and clarity on tax,” he said.

Ambani highlighted how India's hedge fund-like platforms still lag global peers in terms of flexibility, market depth, and asset class diversity.

“When we run a market neutral strategy to do long-short equities, there are 200 stocks in futures. Globally, because you can do that on cash equities, we can run strategies across 3,000 stocks in the US or 500 in Japan. Say, about a 100 in China. So the depth we get across markets is very different and a lot of the strategies can’t be applied in India but once we resolve this, we will open a new realm of product,” Ambani explained.

Another roadblock that he highlighted was liquidity across non-equity asset classes. “So even if I wanted to run a strategy which is say fixed income arbitrage, credit versus equity, or even something as simple as commodities, there's not enough liquidity or permission available yet,” he highlighted.

He also pointed out that strategies like ETF arbitrage — widely used globally — remain out of reach for domestic funds. “Today we can’t launch an ETF arbitrage strategy in a Cat III because we don't have the ability to short ETFs,” Ambani noted, underscoring the gaps in permissible tools.

Among the starkest differences is leverage — a critical tool for hedge strategies that is still capped domestically. “One of the biggest reasons [for lagging innovation] is that we are capped out on leverage,” Ambani said, calling for a policy rethink. “Even solving for one or two of these gaps can unleash a new realm of product possibilities,” he said.

The recent introduction of SIFs (Specialized Investment Funds) in the mutual fund space is raising fresh concerns about category overlap and investor confusion.

“Unless we can get a clear differentiation between what a SIF can do and what a Cat III can do, the lines will only blur further,” said Ambani. Thus, making it a struggle for investors and product distributors to make informed choices.

He described the regulatory overlap as creating “a structure within a structure,” saying both MF-like Cat III features and SIFs seem to be converging toward each other — making it imperative to define boundaries clearly.

Vikas Sachdeva, Co-Chair of the IVCA Cat III Council, agreed that the emergence of SIFs risks muddying the waters — especially as Cat III products are already misunderstood by many as mere mutual fund proxies.

“That perception could not be further from the truth,” he said, adding that Cat III funds are pooled structures with strong governance, often housing sophisticated strategies beyond mutual fund-like offerings.

He made a strong case for the broader macroeconomic role of alternative capital. “For every $10 million invested in alternatives, $58 million in revenue and 270 jobs are created,” he cited as a finding in IVCA’s latest report on Cat 3 AIFs. “Since 2001, 53 percent of India’s total $1.03 trillion in FDI has come in through alternate investments,” he added.

He also noted that 70% of Cat III fund flows are now into long-only strategies, countering the notion that these are only for short-term or speculative trades. “That itself is a big shift, because these funds were earlier seen as speculative or short-term trading vehicles,” Sachdeva said.

The panel also noted a marked evolution in how family offices approach Cat III vehicles.

“Conversations are increasingly focused on risk-adjusted returns rather than just chasing performance… Long-short, quant, and even multi-asset strategies — despite current constraints — are gaining attention from new-gen family offices,” said Sachdeva.

He added that the biggest misconception is that family offices are all chasing alpha. “They’re not. They are trying to align investments with risk-adjusted goals and cash flow needs,” he said.

Ambani added that most family offices are structured with three priorities: wealth preservation, tax optimization, and legacy planning — and their Cat III allocations reflect this evolving discipline. “A lot of what’s getting defined today is shaped by their experience with risk-return over the last few years. But this will evolve — just as ETFs took decades to reach scale,” he said.

When asked what one regulatory wish they’d make, the answers were immediate. “Leverage,” said Ambani. While Sachdeva said “Access to SIFs for boutique fund managers,” referring to it as a very big gap.

Despite policy roadblocks, optimism abounded. Ambani believes Cat III and SIFs could eventually coexist as complementary avenues, each serving distinct investor cohorts. “It’s early days. But there’s a lot of excitement. Whenever that happens, the category grows. Water finds its path,” Sachdeva added.

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