AIFs are classified into three categories:
Category I AIF – Invest in startups, SMEs, social ventures, and infrastructure projects. Examples: Venture Capital Funds and Angel Funds.
Category II AIFs – Include Private Equity Funds, Debt Funds, and other funds that do not take leverage. These funds focus on long-term investments in unlisted companies or debt securities.
Category III AIFs – Engage in hedge fund strategies, arbitrage, and derivatives trading to generate short-term returns. These funds can take leverage.
What is a Debt Fund under AIF?
One type of AIF is the Debt Fund, which falls under Category II AIFs as per SEBI (Alternative Investment Funds) Regulations, 2012.
Debt Fund AIFs are investment funds that invest in debt securities like corporate bonds, non-convertible debentures (NCDs), commercial papers, and government securities. Their goal is to generate income and capital appreciation while managing risks effectively.
Debt funds: SEBI Guidelines
Debt Fund AIFs cannot use investor money to give loans.
They can only invest in debt instruments that are already issued.
The fund must comply with SEBI’s risk and transparency regulations.
How does it work?
Investors contribute money to the fund, which is then used to buy bonds, non-convertible debentures (NCDs), and other debt instruments issued by companies. The goal is to earn returns through interest payments and capital appreciation.
How are debt funds structured?
Debt Fund AIFs are structured as trusts, with a sponsor setting up the fund and appointing a trustee to oversee its operations. The fund manager handles investment decisions, ensuring compliance with SEBI regulations and optimising returns. Investors contribute capital in exchange for units, representing their stake in the fund’s portfolio.
What do debt funds invest in?
Corporate Bonds
Non-Convertible Debentures (NCDs)
Government Securities
Commercial Papers
Distressed Debt (in some cases)
Debt funds: Regulatory Framework
SEBI’s (Alternative Investment Funds) Regulations, 2012 lay out the guidelines for Debt Fund AIFs. These funds must:
Register with SEBI before operating
Follow investment restrictions, diversification norms, and leverage limits
Submit regular reports to SEBI for transparency
Undergo independent audits to ensure compliance
Who can invest?
High-Net-Worth Individuals (HNIs), family offices, and institutional investors.
The minimum investment requirement is typically ₹1 crore, making it an option for large investors.
How are debt funds managed?
A professional fund management team decides where to invest.
They analyse credit risk, interest rate trends, and economic conditions.
Investments are actively managed, meaning portfolios are adjusted based on market conditions.
Taxation
Interest income is taxed at the fund level based on security type.
Short-term capital gains 36 months — taxed at 20% with indexation benefits.
Dividends — taxed in the hands of investors at their individual tax rates (since DDT was abolished).
Liquidity and lock-in period
Generally medium to long-term investments.
The lock-in period applies (a few years or more).
Units are not publicly traded, meaning liquidity is limited compared to mutual funds.
Redemptions are allowed only as per fund-specific terms.
Debt funds: Investment strategy
Debt Fund AIFs focus on income generation through strategic investments in corporate bonds, NCDs, and government securities. Fund managers perform thorough research to identify high-quality, risk-adjusted returns. Some funds also invest in distressed debt, capitalising on financial recovery opportunities.
Prohibition on direct lending
SEBI regulations prohibit Debt Fund AIFs from direct lending, ensuring they operate solely as investment vehicles rather than lending entities. Instead, these funds invest in marketable debt instruments, reducing credit risk and maintaining market transparency.
