Which AIF Category Delivers the Best Returns? A Data-Driven Comparison of Cat I, II & III

India’s alternative industry has shifted from a peripheral allocation to an institutional core. As pricing efficiency increases in public markets, allocators are evaluating private capital structures regulated by the Securities and Exchange Board of India (SEBI) under the AIF Regulations, 2012. The Indian AIF ecosystem has scaled rapidly over the past decade, both in terms of commitments and deployment, making category-level comparisons essential for informed allocation.

According to SEBI’s cumulative commitments raised investment data, total commitments raised across AIFs stand at ₹15,74,050 crore. Category-wise deployment is as follows:

• Category I: ₹97,988 crore

• Category II: ₹11,64,118 crore

• Category III: ₹3,11,944 crore  
  
  
  

• Category II accounts for more than half of deployed capital. Category III represents nearly 20%, reflecting tactical hedge-style demand. Category I remains under 10%, concentrated in venture and SME capital formation.

Category I AIF
Focus sectors include venture capital, SME, infrastructure and social enterprises. Leverage is prohibited. Minimum tenure generally ranges between five and seven years. Returns are driven by early-stage valuation inefficiencies, operating scale and institutionalisation.

Category II AIF
Includes private equity, growth capital and private credit strategies. Leverage is not structurally permitted. Tenure typically extends six to eight years. Value creation is operational and financial, combining earnings growth with exit optimisation.

Category III AIF
Covers long-short equity, arbitrage, structured credit and hedge-style strategies. Leverage is allowed. Tenure usually ranges from one to three years. Returns are market-linked and dependent on volatility and tactical positioning.

Performance Benchmarks and IRR Ranges

Benchmark data from Preqin and CRISIL AIF sub-category reports indicate the following illustrative gross IRR ranges:

• Category I: 15% to 25% with wide dispersion

• Category II: 18% to 28% for top-quartile funds

• Category III: 5% to 20% annualised, depending on leverage and strategy[2][3]

Dispersion is materially higher in Categories I and III relative to Category II. Median performance in venture-style funds tends to lag the top quartile by significant margins, reflecting manager-dependent outcomes.

Liquidity and Capital Lock-In

Category I and II funds follow drawdown models. Capital is committed upfront but deployed over two to four years. Full realisation may take six to eight years. Liquidity is limited until exit events occur.

Category III funds allow periodic redemption windows but are exposed to mark-to-market volatility. Drawdowns in volatile equity cycles can exceed 20% depending on leverage structure.

Illiquidity premium in Category I and II compensates for capital lock-in but increases reliance on exit timing.

Institutional allocators increasingly evaluate:

• DPI (Distributions to Paid-In Capital)

• TVPI (Total Value to Paid-In Capital)

• PME (Public Market Equivalent)

• Maximum drawdown

• Vintage year dispersion

Category II funds historically show stronger DPI visibility by year five relative to venture-style Category I funds, where realisations may cluster later in the fund life.

Category III funds exhibit higher short-term volatility but faster capital recycling.

Structural Drivers of Category II Dominance

India’s lower mid-market enterprise value range, between ₹100 crore and ₹1,000 crore, remains under-researched relative to large-cap equities. Earnings growth in these segments frequently exceeds 20% CAGR, while valuation multiples remain discounted due to limited liquidity.

Category II managers deploy structured growth capital, enhance governance, optimise capital allocation and pursue IPO or strategic exits. Exit ecosystem maturity has improved with SME IPO platforms and increasing M&A activity.

Operational value creation rather than multiple expansion alone underpins stronger risk-adjusted performance.

The Asymmetry Within Category I

Category I, particularly SME-focused strategies, operates earlier in the growth curve. India’s MSME sector contributes approximately 30% to GDP and 45% to exports, yet institutional equity penetration remains limited.

SME-focused Category I managers can invest at valuation discounts before institutional scaling. Dispersion is high; however, asymmetry exists when underwriting is disciplined and governance intervention is structured.

At Alpha AMC, based in Gurugram, the strategy centres on identifying scalable SME businesses with operating leverage and durable earnings visibility. The emphasis is on research depth, promoter alignment and structured capital support rather than momentum-led entry. Operating within SEBI’s Category I framework allows focused exposure to segments where inefficiencies remain pronounced.[4]

Vintage Risk and Deployment Pace

Vintage year selection significantly influences realised IRR. Funds raised during high-liquidity cycles deploy at elevated multiples, compressing future returns. Funds raised during market corrections often secure attractive entry valuations.

Multi-vintage allocation reduces timing risk. Deployment pacing, follow-on reserve ratios and sector concentration must be evaluated at the commitment stage.

Fee Structures and Net Return Impact

Typical structures include:

• Management fee: 1.5% to 2%

• Carried interest: 15% to 20% above hurdle

• Hurdle rate: 8% to 10%

European waterfall structures protect LP capital by ensuring full capital return before carry distribution. Net IRR often compresses 300 to 500 basis points from gross IRR, depending on fee terms.

Alignment through GP commitment materially improves incentive symmetry.

Comparative Snapshot

• Return Consistency: Category II highest

• Asymmetric Upside: Category I highest

• Liquidity Flexibility: Category III highest

• Volatility: Category III highest

• Capital Lock-In: Category I and II highest

For a 20% alternatives allocation:

• 50% to 60% Category II

• 20% to 30% Category I

• 10% to 20% Category III

Within Category I, manager selection is critical. Emphasis should be placed on sourcing capability, governance oversight, exit planning and promoter partnership. SME investing requires deep bottom-up diligence and sector-specific insight.

Alpha AMC’s SME-focused mandate positions it by targeting scalable businesses before valuation expansion; the strategy seeks to capture structural inefficiency rather than cyclical momentum.

Conclusion

No AIF category universally delivers the highest returns across all cycles. Category II offers the strongest track record of consistent institutional performance driven by operational value creation. Category I provides an asymmetric opportunity in undercapitalised SME segments when manager underwriting is rigorous. Category III delivers tactical alpha but with higher volatility sensitivity.

For investors seeking durable private market exposure in India, disciplined allocation across categories, combined with manager-specific diligence, remains the optimal approach. Structural inefficiency, governance alignment and patient capital determine outcomes more than the regulatory label alone.