What is a Category II AIF? | VRM Capital Partners

6 min read · By Viren Makwana

Category II alternative investment funds are now the backbone of India’s private markets. As of 30 June 2026, they accounted for about ₹13 lakh crore of the industry’s ₹17.5 lakh crore in commitments, roughly three-quarters of the total. If you are an HNI or family office being offered a private equity, private credit or real estate fund, it is very likely a Category II AIF.

This note explains what that label means, the rules that shape these funds, and what to check before you commit.

What an AIF is

An alternative investment fund is a privately pooled vehicle registered with SEBI under the AIF Regulations, 2012. It raises money from a limited number of sophisticated investors through a private placement memorandum (PPM), not a public offer.

SEBI sorts AIFs into three categories:

Category I funds invest in areas the government wants to encourage, such as start-ups, SMEs, infrastructure and social ventures.
Category II funds are everything that does not fit Category I or III and does not use leverage beyond day-to-day needs. Private equity, private credit, real estate and fund-of-funds strategies sit here.
Category III funds trade with leverage and complex strategies, such as long-short hedge funds.

The rules that shape a Category II fund

Rule	What it means
Minimum investment	₹1 crore per investor (₹25 lakh for the manager’s employees and directors). Accredited investors may go lower where the scheme allows.
Minimum fund size	₹20 crore per scheme
Maximum investors	1,000 per scheme (accredited investors are exempt from this cap and from the ₹1 crore minimum)
Structure	Close-ended, with a minimum tenure of three years. Extensions of up to two years need approval from two-thirds of unitholders by value.
Concentration	No more than 25% of investable funds in one investee company
Borrowing	A last resort, mainly to cover investors who miss a capital call: up to 30 days, at most four times a year, capped at the lower of 20% of the investment or 10% of investable funds. The defaulting investors bear the cost.
Manager’s own money	The sponsor or manager keeps a continuing interest of 2.5% of the corpus or ₹5 crore, whichever is lower

The last rule matters more than it looks. It means the manager has its own money in the same fund as you.

How returns and tax work

Category II funds have pass-through status for tax. Income other than business income is taxed in the investor’s hands, keeping its character: capital gains stay capital gains, interest stays interest. The fund deducts 10% tax at source on distributions to resident investors.

Fees are not capped by SEBI and are set out in the PPM. A typical structure is a 1–2% annual management fee, a hurdle (a minimum return to investors before the manager shares in profits, often 8–10% a year), and carried interest of 10–20% of profits above the hurdle.

You rarely hand over the full commitment on day one. Managers “draw down” capital as they find deals, so your money is invested over one to three years and returned as investments exit.

What changed recently

SEBI has been loosening the rules for larger, sophisticated investors while tightening reporting for everyone:

November 2025: SEBI created schemes open only to accredited investors and cut the minimum ticket for a “large value fund for accredited investors” from ₹70 crore to ₹25 crore. Such funds may put up to 50% in one company.
December 2025: pension funds under NPS were allowed to invest in Category I and II AIFs, and SEBI required AIF compliance officers to hold NISM Series III-C certification from January 2027.
2026: from February, managers must upload the NAV of each unit class to the depositories through their registrar.

What to check before you commit

The team and its record. Ask for realised returns, not just paper gains, and how many past deals the current team actually led.
The strategy and ticket size. A credit fund, a growth equity fund and a real estate fund have very different risk and cash-flow profiles.
Fees and hurdle. Model what you keep at a 12%, 15% and 18% gross return.
Liquidity. Your money is locked in for the fund’s life. Make sure the tenure and extension terms suit your own plans.
Valuation and reporting. Ask how often NAV is calculated, by whom, and what quarterly reporting you will receive.
Conflicts. Check whether the manager or sponsor co-invests, earns fees from investee companies, or runs competing funds.

Category II AIFs can give access to returns and deals that public markets do not offer. They also lock in your money and depend heavily on the manager. Read the PPM in full, and take independent advice before you sign the contribution agreement.

Sources

This article is for general information only and is not investment, legal or tax advice, or an offer or solicitation to buy or sell any security or fund units. Figures are drawn from public sources as of the date shown and may change. Speak to a qualified adviser before making any investment decision.