Category I, II, and III AIFs, Different Roles, Different Rhythms

India’s AIF regulatory framework is divided into three categories, each with a distinct set of objectives and capital characteristics. The quarterly data released by SEBI as of March 31, 2025 reflects how these categories operate in practice and how they differ in scale, investor base, and fund design.

Category I AIFs, which include funds focused on infrastructure, early-stage enterprises, and social impact, have raised ₹49,373 crore and deployed ₹42,931 crore. These funds are smaller in size and typically serve targeted purposes, such as supporting SMEs or early innovation. Deployment is usually in the form of unlisted equity, convertible instruments, or mission-driven capital with policy alignment.

This category often attracts catalytic capital, investors willing to absorb risk for long-term ecosystem value. Development finance institutions (DFIs), sovereign impact funds, CSR-linked family offices, and climate-oriented philanthropies commonly participate in these vehicles.

The capital here is less about return maximisation and more about creating enabling infrastructure, be it financing green hydrogen pilots, tech-enabled agri platforms, or urban mobility solutions. While returns still matter, Category I AIFs tend to be judged as much by their downstream effects as by IRR.

The fund structures are also bespoke, often anchored by concessional capital or first-loss guarantees, to attract private investors. As blended finance becomes more mainstream, Category I AIFs may play a critical role in channeling such structures into India’s growth agenda.

Category II AIFs form the core of the industry. With ₹10.3 lakh crore in commitments, ₹3.66 lakh crore raised, and ₹3.32 lakh crore deployed, they account for over 75% of total commitments across all categories. These funds include private equity, venture capital, private credit, and hybrid strategies. They are commonly used by institutions, family offices, and international investors to access longer-horizon, less-liquid opportunities in Indian private markets.

Their scale also reflects confidence in the governance and structuring frameworks that Category II funds typically operate under. Investors in these funds range from domestic institutions and endowments to global pensions, sovereign funds, and ultra-high-net-worth individuals looking for asymmetric alpha and deeper participation rights.

The investment themes under Category II are diverse, ranging from control buyouts and growth equity to distressed asset turnarounds and venture growth. Because these funds span multiple risk-return profiles, fund managers in this segment are increasingly offering multi-strategy platforms that blend private equity with structured credit, or early-stage tech with infrastructure yield.

These funds typically have drawdown structures, multi-close fundraising cycles, and complex waterfalls with co-investment rights, hurdle rates, and preferred returns. The sophistication of these structures reflects the level of negotiation and alignment that institutional capital demands.

Because of their complexity and duration, Category II funds also tend to have more disciplined pacing and a longer gestation before deployment ramps up. Once deployed, however, the capital tends to be more patient, with holding periods ranging from 5 to 10 years depending on the strategy.

Category III AIFs are used for public market strategies and shorter investment cycles. These funds have raised ₹1.47 lakh crore and deployed ₹1.63 lakh crore. They primarily invest in listed equity and debt instruments through long-short, arbitrage, and quant strategies. These vehicles appeal to HNIs and NRIs looking for differentiated, actively managed exposure to public markets, often with higher liquidity and shorter holding periods than Category II.

Unlike traditional PMS or mutual fund structures, Category III AIFs allow for leverage and derivatives, offering managers flexibility to run volatility-managed portfolios, directional long-short, or event-driven strategies.

They also serve as a bridge for investors transitioning from traditional long-only public equity investing to more nuanced, hedge-style approaches. The appeal lies in their ability to generate alpha while managing downside risk, especially during volatile or range-bound markets.

The investor base here is more dynamic, often responding to market signals and macro shifts. Many family offices use Category III AIFs as allocation overlays or tactical allocation tools. The rise of algorithmic and quant-driven strategies has further expanded the footprint of Category III funds, particularly among tech-savvy HNIs and second-generation wealth holders.

Each category also reflects a different investor profile. Category I often involves catalytic or mission-driven capital. Category II includes a mix of institutional, domestic, and foreign investors looking for scale, duration, and portfolio diversity. Category III is more oriented toward market-aware individual investors and family offices.

It is about the intent. Category I investors often seek ecosystem outcomes. Category II investors seek control, governance, and optionality. Category III investors seek flexibility, liquidity, and real-time manager insight.

These distinctions extend beyond regulation into actual fund behaviour. Category II funds are typically slower to raise but more predictable in deployment. Category III funds are more responsive to market movements. Category I funds operate with bespoke mandates and targeted capital objectives.

The category framework, while rooted in regulatory definition, has evolved into a practical classification system for risk appetite, investment structure, and investor intent. For fund managers and investors alike, understanding these category-level differences is essential for aligning expectations and structuring funds effectively.

Fundraising strategy, LP communication, audit frequency, and even internal team design vary based on category. AIF managers now build dedicated verticals – investment, legal, investor relations – tailored to the rhythm of the category they operate in.

What started as a compliance classification is now a core part of go-to-market and fund design strategy.

As the AIF industry grows, these categories are likely to evolve further in how they are used and interpreted. But the underlying segmentation remains useful, providing clarity in a market that is otherwise increasingly diverse in strategy and structure.

Over time, we may see hybrid fund formats, fund-of-AIF platforms, or even listed AIF-like structures. But the core distinction, between capital that is slow and structural (Category II), fast and tactical (Category III), or purpose-led (Category I), will remain relevant.

In many ways, these categories mirror the evolution of India’s broader capital markets, diversifying, maturing, and becoming more tailored to distinct investor cohorts. Understanding the rhythm of each category is essential to navigating India’s evolving alternatives landscape with clarity and conviction.

Get clarity on fund structures and priorities via Private Capital, Public Impact, From TVPI to DPI, and The Strategic Blueprint Behind Value Creation in VC & PE.

Frequently Asked Questions