For HNIs and UHNIs, diversification isn’t just about adding more asset classes —it’s about adding the right asset classes. And that’s where Category III Alternative Investment Funds (AIFs) come in.

They are often called India’s hedge funds, promising high risk-adjusted returns through
long-short strategies, arbitrage, and derivatives trading. But the real question is

1. Do they actually deliver superior returns, or is the complexity just an illusion of control?
2. More importantly, should HNIs actively allocate a portion of their wealth to these funds?

How Category III AIFs Operate Differently Break it down.

Unlike mutual funds or Portfolio Management Services (PMS), Category III AIFs don’t just track the market—they manoeuvre through it.

1. Long-Short Strategies

Instead of relying solely on market growth, these funds hedge risks by holding long (buy) and short (sell) positions simultaneously. This means they can make money even when markets are falling.

2. Arbitrage & Derivatives Trading

By identifying price inefficiencies across different securities or markets, these funds aim for absolute returns, making them less dependent on overall market movements.

3. Private Investment in Public Equity (PIPE) Deals

Investing in listed companies at a discount offers a unique way to gain exposure to fundamentally strong businesses.

The idea? Not just riding the market but controlling the risk-reward equation —something
Traditional investments struggle to achieve.

Why More HNIs Are Allocating Capital to These Funds

We’re seeing a clear trend —sophisticated investors are increasing their allocations to
Category III AIFs, despite their complexity. Why?

1. Protection Against Volatility – The long-short approach helps these funds stay resilient
even in a turbulent market. They can outperform during corrections while still participating in
uptrends.

2. Enhanced Returns – Because these funds are not restricted to a long-only strategy,
They can generate returns in both rising and falling markets —a critical advantage for wealth
preservation and growth.

3. Diversification from Traditional Equities – Unlike direct stock investing, mutual funds, or
PMS, these funds introduce low-correlation strategies that act as a buffer against pure equity
exposure.

What Investors Need to Watch Out For

1. Higher Costs & Fees – Unlike mutual funds or PMS, hedge fund-style AIFs charge both a management fee and a performance fee, which can eat into net returns.

2. Taxation is NOT investor-friendly – Unlike Category I & II AIFs, where income is taxed at the investor level, Category III AIFs pay tax at the fund level, impacting post-tax gains.

3. Complexity & Risk – These funds employ sophisticated strategies that require deep market expertise. Not all funds execute them well, and wrong bets can magnify losses .

Final Thoughts: Should You Invest in Category III AIFs?

My view? If you’re an HNWI or UHNI with a strong risk appetite and want exposure to
hedge-fund-like strategies, a tactical allocation to Category III AIFs makes sense.

1. It’s not a replacement for your core investment portfolio.
2. It’s a satellite strategy that can enhance risk-adjusted returns while providing some downside protection

What do you think? Would you consider adding these funds to your portfolio, or do you see
them as an unnecessary complexity? Let’s discuss!

—
CA. Prakhar Goyal
Investor | Chartered Accountant | Partner, Satyanarayan Goyal & Co.