Alternative Investment Funds Vs Mutual Funds - Which Is Better?

In the world of investing, there are different paths that one can take to achieve their financial goals and targets. People like to invest to generate passive income over a period of time. Two prominent investments that focus on passive investing are mutual funds and alternative investments. A clear idea about them before investing can help you determine the right strategy.

In this blog post we will look at the key differences between mutual funds and alternative investment funds. We will try to understand what mutual funds and alternative investment funds are, their advantages and disadvantages and how they are different.

But before we cover the difference between the two, let’s try to understand what passive investing is and how it works since both mutual funds and alternative investment funds are popular as passive investment instruments.

What Is Passive Investing?

Passive investing is a long-term investment strategy involving buying and holding assets for a longer period of time instead of frequent turnover to match market expectations. Passive investing aims to blend and match the market performance rather than surpass it. Passive investments include ETFs, Index Funds, Fixed Deposits, Corporate Bonds, Startup Equity, etc. As the name suggests, passive investments require comparatively lesser active involvement and regular management.

Key Considerations For Passive Investors

The following are some of the primary factors to keep in mind while choosing a passive investment instrument:

• Long-Term Focus: Passive investing is typically best for the long term, where you buy and hold the security to yield market returns. A longer time frame allows you to benefit from compounding and alleviates the fluctuations due to short-term market volatility.
• Right Scheme For Your Risk Profile: Consider your risk tolerance before investing.
• Performance Expectations: Investors should have realistic expectations to match their investment performance with the underlying asset class and not expect to exceed it.
• Market Conditions: The investment returns can be impacted because of the market conditions. In a bull market, passive investing gives expected returns vis a vis bear market, where the returns are negative.

Now that you understand what passive investing is and the factors you need to consider when choosing passive investments, let’s understand what mutual funds and alternative investment funds are and how they fare as passive investments.

What Are Mutual Funds In India?

Mutual funds are a pool of money managed by professional fund managers. Multiple investors invest money for a particular objective, which is then invested in promising securities. Thousands of options are there when planning to invest in mutual funds. There are different types of Mutual Funds, which are detailed below. 

• Index Funds: Index funds are mutual funds that copy the performance of popular market indices. The fund managers do not actively select industries and stocks to build the fund’s portfolio. They invest in all the stocks that make up the index to be followed with similar weightage as that of each of the stocks in the index.
• Equity Funds: An equity fund is a mutual fund if it contains more than 60% of equity shares of different companies, with the remaining share going to money market instruments or debt securities as per the financial goal of the scheme. The investment decisions like investing in growth-oriented or value-oriented companies lie with the fund manager.
• Debt Funds: Contrary to equity funds, debt mutual funds invest in fixed-income securities like government bonds, corporate bonds, treasury bonds, etc. They suit investors seeking a predictable, fixed income without major default risks.
• Hybrid Funds: Hybrid funds invest in a combination of both equity and debt securities, thus offering a balance between growth and stability.

What Are Alternative Investment Funds In India? 

As the name suggests, alternative investment funds or AIFs are funds regulated by the Securities and Exchange Board of India (SEBI) under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, that invest in assets other than traditional ones, like stocks, fixed deposits, and mutual funds, due to their non-market-linked nature. They offer better returns than fixed deposits and better security than stocks. Some of the examples of alternative investments that can offer predictable returns are:

• Fractional Real Estate: The business model of Fractional Real Estate involves a pool of investors' funds leading them to purchase a property. While they are fractional owners of the property, they enjoy passive ownership of highly valued assets. The single-ownership financial burden is reduced, while investors enjoy a high return on investment from the commercial property. 
• LoanX: In LoanX, a type of securitised debt instrument, each opportunity entails receiving returns from a pool of many loans provided to individuals, businesses, or other entities. An NBFC has already provided these loans, and an investor gets direct access to the returns these loans generate without dealing with the hassles of the process. 
  LoanX by Grip presents a more streamlined approach towards short tenure, fixed income, and regulatory-compliant products, enabling investors access to new investment opportunities.
• LeaseX: LeaseX, a type of asset leasing, is a unique investment product that allows investors to become lessors and earn predictable returns by leasing different kinds of assets to different companies. 
  LeaseX offers investments backed by real assets, such as equipment or property. It provides a secure form of collateral which is often more reliable than other forms of investing. In addition, it offers low initial capital investment due to its pooled nature.
• Startup Equity As An Investment Tool: Startup Equity investment is a passive investment where you put a certain amount of capital into a business in exchange for receiving financial returns. Startup Equity describes company ownership as a percentage of your stock shares. Startups offer stocks at a certain amount to investors. Investors buy the shares and receive returns if the valuation goes up in the future.

What Is The Difference Between AIF And Mutual Funds?

In essence, both mutual funds and alternative investment funds follow the same investment strategy of pooling money from a number of individuals working towards the same financial objective and investing the pooled capital into suitable instruments. The core difference between AIF and Mutual funds lies in the asset class in which the money is invested. For mutual funds, as we understood above, the underlying asset can be equity, debt instruments, or a combination of both. On the other hand, an AIF invests in alternative asset classes that have very little correlation with traditional instruments and markets.

AIFs invest in alternative investments. An alternative investment is a financial asset that does not fall into one of the conventional investment categories of stocks, bonds or cash. Examples of alternative investments can be peer-to-peer lending, private equity, commercial real estate, farmland investing, etc. Traditionally, alternative investment funds have been accessible only to high-net-worth individual investors and financial institutions due to high minimum investment amounts and high associated fees. Being limited to a handful of investors, the liquidity in alternative investments is usually lower than that in mutual funds or other traditional instruments.

The minimum investment amount for a SEBI-regulated AIF in India is set to be INR 1 crore. This minimum investment amount is lower for directors, management personnel or employees of an AIF at INR 25 lakhs. In comparison, Mutual funds are accessible and affordable for average retail investors and can be invested in for as little as INR 500. Mutual funds minimum investment can go as little as INR 100 for lumpsum as well.

In terms of volatility, some AIFs, such as hedge funds, can be linked to the traditional markets and may reflect volatility in the markets in terms of fluctuations in investment value. However, others, such as private equity funds, are unrelated to the stock market and, hence, are largely unaffected by market fluctuations. On the other hand, for mutual funds, volatility largely depends on the types of assets the fund invests in and its risk profile. Even though equity mutual funds have a direct correlation with the stock market, their volatility can vary depending on the type of stocks invested in. Similarly, debt mutual funds, even though affected by market fluctuations, are comparatively less volatile than equity funds. Hybrid funds, which invest in a combination of both equity and debt instruments, lie somewhere in between in terms of their risk profile and volatility.

Mutual funds are regulated by SEBI and the Association of Mutual Funds in India (AMFI). The regulator framework surrounding mutual funds and asset management companies (AMCs) offering these mutual funds in India follows stringent registration, compliance, and disclosure norms under different rules and regulations of SEBI and AMFI guidelines. SEBI regulates Alternative Investment Funds under the SEBI (AIF) Regulations of 2012. SEBI has classified AIFs in India into three categories:

• Category I: AIFs that invest in start-ups, early-stage ventures, social ventures, SMEs, infrastructure or other sectors or areas that the government or regulators consider as socially or economically desirable.
• Category II: AIFs that do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI (AIF) Regulations. Category II includes the funds that cannot be categorised under either Category I or Category III.
• Category III: AIFs that employ complex or diverse trading strategies and may employ leverage through investment in listed or unlisted derivatives.

Differences Between Alternative Investment Funds And Mutual Funds – Quick Summary

The following table summarises the key differences between alternative investment funds and mutual funds for different parameters:

Conclusion

Passive investment is a lucrative way towards wealth generation. It requires investors’ minimum involvement and time. However, researching and analysing the benefits and drawbacks of the available options is essential before investing. Ultimately, the money matters and capital appreciation is the key attraction for any investment decision.

In pursuing returns, the choice between mutual funds and alternative investments ultimately depends on your investment goals, risk tolerance, and time horizon. Some investors choose to allocate a portion of their portfolio to alternative investments while retaining the investment in mutual funds. In contrast, others prefer exposure to alternative investments more than mutual funds. This hybrid approach aims to capture the benefits of both worlds.

Passive investing does not outsmart the market. It mirrors the market in your portfolio and allows you to enjoy returns in the long term. Curious to learn more about passive investing instruments? Grip is the platform for you! It offers a range of investment opportunities and guides you through the process.

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