AIFs and Private Credit: Returns, Liquidity and the New Regulatory Risk
Current position
Alternative Investment Funds are privately pooled vehicles registered under SEBI’s AIF framework. Many private-credit strategies operate through Category II AIFs, but the fund documents, investment mandate and actual portfolio determine classification and risk. RBI directions also restrict certain investments by regulated entities in AIF schemes where downstream exposure can create evergreening or indirect debtor exposure.
How it works
Investors commit capital to a fund that lends, buys debt or structures securities. Cash may be drawn over time, and distributions depend on borrower payments, exits and recoveries.
A stated internal rate of return is not a guaranteed coupon. Fees, drawdown timing, defaults, restructurings, valuation changes and delayed exits affect realised returns.
Security can improve recovery prospects but does not guarantee full or timely repayment. Charge perfection, priority, collateral liquidity and inter-creditor terms matter.
| Issue | Current position | Why it matters |
|---|---|---|
| Structure | Privately pooled AIF | Not a bank deposit or mutual fund |
| Typical category | Category II for many debt strategies | Read scheme mandate and portfolio |
| Key risk | Illiquidity and concentrated credit | Headline yield is not realised return |
Practical example
An AIF lends ₹100 crore at a 16% target return against shares and receivables. If the borrower misses payments and collateral falls 40%, the fund may extend maturity or mark the asset using valuation policy. The investor cannot assume a 16% cash return or immediate redemption merely because the original term sheet quoted that rate.
Action checklist
- Read the private placement memorandum, contribution agreement and fee waterfall.
- Review borrower and sector concentration, security and covenant quality.
- Understand drawdowns, lock-in, tenure extensions and distribution rules.
- Distinguish gross target return from net realised cash.
- Check related parties, valuation policy and conflict management.
Evidence and document checklist
- SEBI registration and scheme documents.
- Portfolio, concentration and valuation reports.
- Loan/security and inter-creditor documents.
- Capital-call and distribution statements.
- Auditor, custodian and trustee reports where applicable.
Common mistakes
- Calling target IRR guaranteed interest.
- Comparing an AIF with a fixed deposit using only coupon.
- Ignoring fees and capital-call timing.
- Assuming collateral value equals recovery value.
Red flags
- Repeated maturity extensions without transparent valuation.
- Large exposure to sponsor-linked borrowers.
- Returns paid from fresh capital rather than borrower cash.
- Side letters create unequal rights without disclosure.
Escalation and complaint route
Investors should first use the manager, trustee and scheme grievance mechanism. Eligible securities-market grievances may be taken through SEBI’s prescribed channels. Default, enforcement and suitability disputes require document-specific legal and investment advice.