Why Category III AIFs are defining India’s investing landscape

Tejas Khoday

Indian investors have linked mutual funds and stocks to wealth creation for decades. But a subtle structural change is now taking place. A growing number of wealthy and seasoned investors are investigating investment vehicles that go beyond the traditional ones in order to better manage downside risk while capturing alpha. Category III Alternative Investment Funds (AIFs) are starting to take center stage. Unlike mutual funds, Category III AIFs are designed for active wealth creation using long-short, arbitrage, and hedging methods, enabling specialised fund managers to produce returns using different strategies across market cycles. They represent the growth of India’s investing ecosystem.

A smarter way to construct portfolios

Hedge fund-style strategies are still used by seasoned investors globally to strike a balance between stability and returns. Category III AIFs in India are adapting that mindset for domestic markets, building resilient portfolios with quantitative, factor-based, and multi-strategy frameworks. Research states that the global hedge fund sector exceeded $5 trillion in 2024, and Sebi’s March 2025 data shows that India’s AIF assets exceeded ₹9.5 lakh crore. Category III funds now account for approximately 15% of the total, a tiny but constantly growing share. These funds provide fund managers with greater flexibility, allowing them to take both long and short positions, employ derivatives to reduce risk, and leverage opportunities across sectors. However, taxation and leverage restrictions remain barriers for long short strategies.

A need for regulatory evolution

As India’s AIF ecosystem deepens, regulatory refinement will play a key role in sustaining innovation without compromising investor protection. Sebi has already taken progressive steps, such as tightening disclosure norms, improving valuation practices, and mandating independent trustees for fund oversight. However, as fund strategies become more sophisticated, frameworks around risk reporting, liquidity management, and performance benchmarking need to evolve too.

For instance, a 2024 PwC report highlights that global institutional investors are demanding greater transparency and governance in alternative funds. India is likely to follow the same trajectory where innovation and compliance coexist, and fund managers balance creativity with fiduciary discipline. Ultimately, the goal should be to ensure that AIFs not only generate alpha, but also earn investor trust through reliable governance and consistent disclosures.

Integration into modern wealth advisory

Wealth managers are increasingly integrating AIFs into their advisory portfolios to meet the evolving demands of high-net-worth individuals (HNIs). The new-age affluent investor is not just looking for returns; they are looking for differentiation, transparency, and alignment of interest with their fund managers. A recent study showed that over 60% of wealth managers plan to increase AIF allocations within client portfolios over the next two years, driven by the appetite for strategies that go beyond conventional beta. Investors are no longer satisfied with following benchmarks; instead, they want methods that leverage data, technology, and tactical flexibility to take advantage of market inefficiencies.

The rise of the evolving investor

Today, we are seeing a maturation of investor behaviour in addition to the growth of financial products. Creating wealth is no longer about following trends or mindlessly sticking to standards. These days, investors place a high value on structured risk-taking, data-driven insight, and governance. Category III AIFs will probably become the go-to option for active wealth creation, as more investors transition from do-it-yourself trading to professional wealth management.