AIF Categories: Category I vs II vs III Explained
By Trilithon Research Desk · Last updated · 8 min read
Short answer: SEBI places every AIF in one of three categories according to what it invests in and how much risk it may take. Category I covers startups, SMEs, infrastructure and social ventures. Category II covers private equity, private credit and anything that fits neither neighbour. Category 3 AIF covers complex, mostly listed-market strategies that may use derivatives and leverage, and is taxed at the fund level. The minimum commitment is ₹1 crore in each.
3 categories. Set at registration. ₹1 crore. Minimum in each. Cat I and II. Pass-through tax. Cat III. Fund-level tax.
Where we fit: Trilithon manages a SEBI-registered Category III AIF and PMS strategies. We do not run Category I or II funds, so those are explained here neutrally for comparison.
How SEBI sorts AIFs into three categories
Every AIF registered under the SEBI (Alternative Investment Funds) Regulations, 2012 must pick one of three categories when it registers. SEBI’s test is simple: what will the fund invest in, how much risk can it take, and does the wider economy benefit? Funds that back growth sectors the government wants to encourage go into Category I. Funds that do not fit anywhere else, and do not borrow, go into Category II. Funds that trade actively and may use leverage go into Category III.
The label is not cosmetic. It fixes the fund’s structure, its borrowing powers and how its income is taxed, and it cannot be switched later without SEBI approval. Reading the category first tells you most of what you need to know before you open the offer document (PPM).
Category I vs Category II vs Category III at a glance
| Parameter | Category I | Category II | Category III (Cat 3) |
|---|---|---|---|
| Invests in | Startups, SMEs, infrastructure, social ventures | Private equity, private credit, real estate, fund of funds | Listed and traded securities, derivatives, special situations |
| Borrowing | Short-term operational needs only | Day-to-day operational needs only | Leverage permitted within SEBI limits |
| Structure | Close-ended | Close-ended | Open-ended or close-ended |
| Tax | Pass-through | Pass-through | Taxed at fund level |
| Minimum commitment | ₹1 crore | ₹1 crore | ₹1 crore |
| Where returns come from | Exits from growth companies | Exits and interest income | Security selection and trading |
| Cash back to investor | Slow, mostly at exits | Slow, plus coupons in credit funds | Faster, per scheme terms |
Source: SEBI AIF Regulations, 2012 as amended.
Category I and Category II in two minutes
Category I AIF
Think startups, small businesses, roads and power, and social enterprises. Category I funds are patient capital: they hold unlisted stakes for years and return money when those stakes are sold. The full Category 1 AIF guide covers venture capital, angel, SME, social venture and infrastructure funds.
Category II AIF
This is the catch-all category and the home of most private equity and private credit. A Category II fund either buys stakes in established private companies or lends to them. Read the full Category 2 AIF guide for how each type earns and pays out.
Category 3 AIF (Cat III): what makes it different
A Category 3 AIF, also written Cat 3 AIF, Cat III AIF or AIF Category 3, is the one category built around listed markets. It may use derivatives, short positions and leverage within limits set by SEBI, it is the only category that can be open-ended, and it is taxed at the fund level rather than passing income to investors. That combination is why hedge-fund style strategies and focused small-cap funds are registered here.
- Long-short equity: owns stocks the manager likes and shorts ones it does not, to soften market swings.
- SME and microcap equity: concentrates on small listed companies that larger funds cannot hold at scale.
- Absolute return and hedged strategies: uses derivatives to limit downside.
- Event-driven and PIPE: trades around corporate actions or invests through private placements in listed companies.
Permission to use leverage is not the same as using it, so the PPM is where you check what a given fund actually does.
Example: Trilithon Category III AIF
A close-ended fund focused on SME and microcap equities listed on Indian exchanges, with a ₹1 crore minimum commitment, launched in September 2025 (SEBI Reg. No. IN/AIF3/25-26/1808). Read the Category 3 AIF guide or compare it with portfolio management in AIF vs PMS.
Which AIF category fits which goal?
| If you want to… | Look at |
|---|---|
| Back startups or early-stage companies | Category I (venture capital, angel) |
| Fund infrastructure or social-impact projects | Category I |
| Own stakes in established private companies | Category II (private equity) |
| Earn interest by lending to companies | Category II (private credit) |
| Invest in listed small, SME and microcap stocks | Category III |
| Use hedged or long-short strategies | Category III |
| Prefer a shorter horizon with some liquidity | Category III, subject to scheme terms |
Four common misunderstandings about AIF categories
- “A higher category number means a riskier fund.” The number is a classification, not a ranking. Category I carries startup risk, Category II carries exit and credit risk, Category III carries market and leverage risk.
- “Category III is only for traders.” Some Category III funds run concentrated listed-equity portfolios instead of complex hedging.
- “Pass-through means lower tax.” Pass-through decides who pays the tax, not how much is paid in the end.
- “Same ₹1 crore ticket, so they are interchangeable.” The ticket matches, but the horizon, liquidity and risk do not.
Not sure which category fits you?
Book a call and we will talk through your horizon and liquidity needs, and say plainly if a Category III AIF is not the right tool. Book a call. Category III AIF.
Related reading
Category I AIF · Category II AIF · Category III AIF in India · AIF vs PMS · How to invest · AIF taxation across categories
Disclaimer: Investments in securities markets are subject to market risks, including the possible loss of the entire principal. Past performance is not indicative of future results. This page is for information only and is not investment, tax or legal advice, or an offer to sell or solicit securities. Category III AIFs are taxed at the fund level. Category III AIF: Trilithon (SEBI Reg. No. IN/AIF3/25-26/1808), registered under SEBI (AIF) Regulations, 2012. Please read the PPM and all scheme documents before investing.
AIF categories: frequently asked questions
What is the difference between Cat 1, Cat 2 and Cat 3 AIF?
Cat 1 AIFs back startups, SMEs, infrastructure and social ventures. Cat 2 AIFs cover private equity, private credit and other funds that fit neither neighbour. Cat 3 AIFs run complex, mostly listed-market strategies, may use derivatives and leverage within SEBI limits, and are taxed at the fund level. Cat 1 and 2 are close-ended; Cat 3 can be open- or close-ended.
What is a Category 3 AIF?
A Category 3 AIF (Cat III AIF) is a SEBI-registered pooled fund that employs diverse or complex trading strategies and may use derivatives and leverage within SEBI limits. It can be open- or close-ended and is taxed at the fund level.
Which AIF category is best for HNIs?
No category is best for everyone. Category I and II suit investors who can lock capital for years in unlisted assets. Category III suits investors who want listed-market strategies and a shorter horizon. Your time horizon, liquidity needs and risk tolerance decide the fit.
Can an AIF change its category after registration?
Not on its own. The category is fixed at registration and can change only with SEBI approval.
Which AIF categories are close-ended?
Category I and Category II are close-ended. Category III can be open-ended or close-ended.
How are Category I, II and III AIFs taxed?
Category I and II AIFs generally have pass-through status, so income is taxed in the investor’s hands. Category III AIFs are taxed at the fund level.
What is the minimum investment in an AIF?
₹1 crore per investor under SEBI rules, across all three categories.
Can a Category 3 AIF use leverage?
Yes, within SEBI limits. It is the only AIF category allowed to use leverage and derivatives as part of its strategy.
Are AIF returns guaranteed?
No. AIFs carry substantial risk, including loss of the entire principal. SEBI registration does not guarantee performance.