AIF Category III vs Category I vs Category II: Key Differences in India (2026 Guide)

Monday, Jan 19, 2026

The creation of wealth in India has taken a new turn.

Over the last ten years, listed equity and mutual funds performed exceptionally well. Markets however grow older and competition has gotten bigger and finding true alpha has been more difficult. This is a realignment that has compelled the advanced investors to seek other investments in India not as a diversification but as a fundamental strategy in portfolio.

This is where Alternative Investment Funds (AIFs) come in.

But the numerous investors commit the blunder of taking AIFs as a product type. As a matter of fact, the Category I, Category II and Category III AIFs have entirely different investment philosophies, risk frameworks, liquidity structures, and taxation regulations.

If you already:

invest in PMS,
are considering the most suitable PMS to invest, or
are actively investigating other investment funds India,

then, it is vital, not optional, to know what category of AIF fits your objectives.

The practical and easy to understand comparison of AIF Category I vs Category II vs Category III is clear and investor-first and this guide will assist you to decide where Category III AIFs will belong in a modern strategic portfolio.

What Are the Alternative Investment Funds (AIFs) in India?

Alternative Investment Funds are pooled investment vehicles governed by SEBI, which targets investors who require a different opportunity that is not currently available in the traditional asset class like equities, fixed income and mutual funds.

AIFs offer an opportunity to:

Private markets
Structured capital
Pre-IPO investments
Preferential allotments, and
Niche alternative assets.

In India, AIFs are governed by the SEBI (Alternative Investment Funds) Regulations, which classify them into three categories based on investment intent and strategy.

Key structural features common across all AIFs include:

Minimum investment of ₹1 crore per investor
Participation typically restricted to HNIs, UHNI, family offices, and institutions
Higher flexibility compared to mutual funds
Greater responsibility on fund managers for due diligence and governance

However, this is where similarities end. Each AIF category behaves very differently in practice.

Category I AIF: Investing for Impact, Not Immediate Alpha

Category I AIFs are designed with a nation-building and developmental mindset. SEBI created this category to encourage capital flow into sectors that are beneficial for India’s long-term economic and social development.

These funds typically invest in:

Early-stage startups
Infrastructure projects
SMEs
Social ventures, and
Innovation-led businesses.

From an investment standpoint, Category I AIFs demand extreme patience. Capital is often locked for long durations, sometimes exceeding a decade, with returns dependent on the eventual success or failure of early-stage ventures.

Unlike PMS investing or Category III AIFs, liquidity is minimal, and exits depend heavily on IPOs, acquisitions, or government policy continuity.

Risk in Category I AIFs is not market volatility—it is business survivability. Many investments may fail, while a small number generate outsized returns. As a result, outcomes tend to be binary rather than consistent.

Category I AIFs are best suited for:

Institutions with patient capital,
Investors aligned with impact investing, and
Those who can afford long lock-in periods without interim liquidity.

For investors seeking portfolio compounding, tactical flexibility, or strategic allocation alongside PMS, Category I AIFs often feel restrictive.

Category II AIF: Structured Private Capital with Limited Flexibility

Category II AIFs form the largest segment of the alternative investment market in India. These funds primarily focus on structured investments in unlisted businesses, private equity, real estate, private debt, and stressed assets.

Category II AIFs are typically closed-ended and operate with a defined investment horizon. Capital is deployed gradually, locked in for the fund’s tenure, and returned upon exit events such as IPOs, strategic sales, or refinancing.

The core philosophy here is risk-managed capital allocation, rather than opportunistic alpha generation.

From a return perspective, Category II AIFs aim to deliver steady, predictable outcomes driven by:

Valuation arbitrage
Operational improvement
Financial restructuring, or
Sectoral tailwinds.

However, flexibility remains limited. Once capital is committed, investors have minimal control or visibility into tactical adjustments. Unlike PMS or Category III AIFs, dynamic asset allocation is not a priority.

Taxation in Category II AIFs follows a pass-through structure, meaning income is taxed at the investor level based on its nature. For high-income investors, this can complicate tax planning and reduce post-tax returns.

Category II AIFs are generally suitable for:

Investors seeking structured exposure to private markets,
Family offices with long-term capital, and
Those comfortable with illiquidity and delayed outcomes.

Category III AIF: The Most Sophisticated AIF Structure in India

Category III AIFs are built for experienced investors who understand market cycles, risk management, and capital efficiency.

This category allows fund managers to deploy advanced, flexible, and market-linked strategies across both listed and unlisted securities. Unlike Category I and II, Category III AIFs can actively rebalance portfolios, respond to market dislocations, and participate in time-sensitive opportunities.

In 2026, Category III AIFs are increasingly being viewed as the natural evolution of PMS investing.

These funds can invest in:

Listed equities
Unlisted companies
Pre-IPO opportunities
Preferential allotments
Structured instruments, and
Hybrid strategies.

What truly sets Category III AIFs apart is taxation at the fund level. Investors do not face annual tax liabilities during the investment period. Instead, taxation applies only at the time of exit or redemption, allowing capital to compound efficiently within the fund.

Liquidity, while not as high as PMS, is meaningfully better than Category I and II AIFs—especially in open-ended Category III structures.

For investors who already understand PMS strategy, portfolio management strategies, and strategic portfolio construction, Category III AIFs offer a powerful extension into alternative assets.

Category I vs Category II vs Category III AIF

Parameter	Category I AIF	Category II AIF	Category III AIF
Primary Objective	Development & Impact	Structured Private Capital	Market-Linked Alpha
Typical Investments	Startups, Infra, SMEs	PE, Debt, Real Estate	Listed + Unlisted
Strategy Flexibility	Low	Moderate	High
Liquidity	Very Low	Low	Moderate to High
Structure	Closed-Ended	Closed-Ended	Open / Closed
Taxation	Pass-through	Pass-through	Fund-level taxation
Ideal Investor Profile	Institutions, Impact Investors	PE-style Investors	Sophisticated HNIs

PMS vs AIF: How Should Investors Think About Both?

Portfolio Management Services (PMS) continue to remain one of the most popular choices for investors seeking direct equity exposure with professional management.

With a minimum investment for PMS of ₹50 lakh, PMS offers transparency, individual ownership of securities, and a strong alignment with listed equity markets.

However, PMS strategies are inherently limited to:

Listed equities
Market liquidity, and
Investor-level taxation.

As portfolios grow, many investors realize that listed markets alone may not capture the full spectrum of opportunities available in India’s evolving economy.

This is where alternative investment management becomes relevant.

Rather than choosing PMS or AIF, sophisticated investors increasingly use PMS as the core and Category III AIFs as the satellite, creating a diversified, multi-layered strategic portfolio.

Example: Choosing the Right AIF Category

Consider three investors:

Investor A is a senior professional who already invests in PMS and wants to enhance returns while improving tax efficiency. This investor values flexibility, access to private opportunities, and disciplined risk management.
→ Category III AIF is the natural next step.

Investor B is a global institution with a mandate to fund infrastructure and social development projects, with no short-term liquidity needs.
→ Category I AIF fits the mandate.

Investor C is a family office seeking structured exposure to private equity with predictable outcomes.
→ Category II AIF works best.

The right choice depends not on returns alone, but on strategy alignment, liquidity needs, and portfolio role.

Why Green Portfolio Focuses on Category III AIF

At Green Portfolio, our investing journey began with PMS investing in listed equities, where we built a track record of identifying strong businesses early.

With India Infinite Fund, we are extending that philosophy into the private market space—without compromising on discipline or governance.

Our Category III open-ended AIF structure allows us to:

Access pre-IPO investments and preferential allotments
Back founder-led growth stories
Maintain diversification across market segments, and
Apply rigorous multi-layered screening.

We focus on manufacturing-oriented opportunities, aligned with India’s structural growth story, while remaining sector-agnostic when conviction is high.

This is not momentum chasing. It is capital allocation with purpose, backed by deep research, strong governance filters, and long-term vision.

Final Thoughts: Making the Right AIF Choice in 2026

Alternative investments are no longer optional for serious investors—they are essential.

Category I AIFs support nation-building.
Category II AIFs structure private capital.
Category III AIFs empower strategic investors.

For those who already understand PMS strategy, portfolio management strategies, and alternative investments in India, Category III AIFs offer the most balanced combination of flexibility, tax efficiency, and access to exclusive opportunities.

Ready to Explore Category III AIF Investing?

Discover how India Infinite Fund can complement your PMS strategy and elevate your portfolio.

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