Category III AIF cannot invest into mutual fund except liquid mutual funds

Can a Category III AIF invest in Mutual Funds on a permanent basis as a part of their multi asset portfolio?

A Category III Alternative Investment Fund (AIF) requested the Securities and Exchange Board of India (SEBI) for an Informal Guidance by way of the interpretative letter under the provisions of the SEBI (Informal Guidance) Scheme, 2003. Read More: SEBI Interpretative Letter on Category III AIF Investments

The AIF approached SEBI seeking clarity on whether a Category III AIF can invest in Mutual Funds on a permanent basis as a part of their multi-asset portfolio.

SEBI in reference to the said letter provided the following comments:

1.  In terms of Regulation 18 of AIF Regulations, Cat III AIFs may, inter alia,

a. Invest in securities of listed or unlisted investee companies, derivatives, units of other AIFs or complex or structured products.

b. Deal in goods received in delivery against physical settlement of commodity derivatives.

c. Buy or sell credit default swaps in terms of the conditions as may be specified by the Board from time to time.

d. Engage in leverage or borrowing subject to consent from the investors in the fund and subject to a maximum limit, as may be specified by the Board.

2. In terms of Regulation 2(1)(o) of AIF Regulations, “investee company” means any company, special purpose vehicle or limited liability partnership or body corporate or real estate investment trust or infrastructure investment trust in which an AIF makes an investment.

3. Thus, investment in Mutual Funds is not covered under permissible investments by a Category III AIF.

4. However, in terms of Regulation 15(1)(f) of AIF Regulations, un-invested portion of the investable funds and divestment proceeds pending distribution to investors of AIFs (including Cat III AIFs) may be invested in liquid mutual funds or bank deposits or other liquid assets of higher quality such as Treasury bills, Triparty Repo Dealing and Settlement, Commercial Papers, Certificates of Deposits, etc. till the deployment of funds as per the investment objective or the distribution of the funds to investors as per the terms of the fund documents, as applicable.

Conclusion: SEBI’s guidance is explicit – a Category III AIF cannot make permanent investments in Mutual Funds as part of its multi-asset portfolio. The regulatory framework underscores the importance of temporary investments in liquid assets during specific fund phases, necessitating careful adherence to SEBI’s stipulations. This insight is pivotal for Category III AIFs navigating the financial landscape, ensuring compliance, and strategically aligning with regulatory expectations for a sustainable and compliant investment strategy.

Thus, a Category III AIF can invest into mutual fund only for a temporary purpose.