Category 2 AIF (Cat II) Explained: Private Equity and Private Credit Funds
By Trilithon Research Desk · Last updated · 7 min read
Short answer: A Category 2 AIF (Cat II AIF) is the residual SEBI category: any fund that is not Category I or III and does not borrow beyond day-to-day operations. That makes it the home of private equity, private credit, real estate and fund-of-funds strategies. These funds are close-ended, run for at least three years, and generally pass income through to investors for tax. The minimum commitment is ₹1 crore.
Residual. Not Cat I or Cat III. 4 fund types. PE, debt, real estate, FoF. 3+ years. Minimum fund term. ₹1 crore. Standard minimum.
Note: Trilithon does not manage Category II funds. Our product is a Category III AIF, and this guide is written to help you compare fairly.
Why Category 2 is called the residual category
SEBI did not describe Category II by what it invests in. It described it by what it is not: any AIF that does not belong in Category I or Category III, and that does not borrow beyond day-to-day operations. That wide definition explains why most private equity and private credit funds in India are registered here.
Like Category I, these funds are close-ended and generally pass income through to investors. The differences from the other two categories are laid out on the AIF categories page. Here we look at Category II itself.
The four kinds of Category 2 AIF
| Fund type | What it does | How cash comes back |
|---|---|---|
| Private equity | Buys stakes in established unlisted companies to help them grow | Sale of the company or a listing |
| Debt (private credit) | Lends to companies, often against security | Interest or coupons, plus repayment at maturity |
| Real estate | Funds property projects or real-estate-linked companies | Project sales, rentals and refinancing |
| Fund of funds | Invests in units of other AIFs | Distributions from the underlying funds |
Private equity vs private credit: two different journeys
Private equity is a bet on ownership. The fund buys part of a company, works with its management, and earns only when the stake is sold for more than it cost. Money often comes back late and in lumps, so the early years can look flat or negative.
Private credit is a loan. The fund agrees terms up front, collects interest through the term, and expects its principal back at maturity. The risk shifts from “will the company grow?” to “will the borrower repay?”, and returns are usually steadier but capped.
Both sit in Category II, yet the questions to ask a manager are different, as the checklist below shows.
Rules that apply to every Category 2 AIF
- Structure: close-ended, with a minimum scheme tenure of three years and extensions possible with unit-holder approval.
- Typical term: private equity and credit funds are commonly set up with a multi-year term plus extension options, as spelled out in the PPM.
- Borrowing: not beyond day-to-day operational needs.
- Hedging: allowed within SEBI guidelines.
- Investor cap: up to 1,000 investors in a scheme.
- Minimum commitment: ₹1 crore per investor.
Questions to ask before committing to a Category 2 fund
For private equity funds
- How many past investments were fully exited, and at what multiple?
- Does the team have real sector expertise, or just capital?
- How does the manager add value after investing?
For private credit funds
- How are borrowers screened, and what security backs each loan?
- What were the defaults and recoveries in earlier funds?
- How concentrated is the loan book, and when does each loan mature?
Tax treatment and who can invest
Category II AIFs generally have pass-through status, which means income is taxed in the investor’s hands and not in the fund. For the contrast with Category III, see AIF taxation across categories. Resident HNIs, NRIs, corporates, trusts, family offices and institutions can invest if they meet the fund’s terms. Steps are in how to invest.
Category 2 or Category 3: how to think about it
If your money can sit untouched for years and you want exposure to private companies or loans, Category II fits. If you want a portfolio of listed securities with market prices, a possibly shorter horizon and a fund that can hedge or use leverage within SEBI limits, look at a Category 3 AIF, which is also taxed at the fund level. The two are tools for different jobs, not rungs on a ladder.
Where Category 2 AIFs can disappoint
- Long wait: distributions depend on exits and repayments, which can slip.
- Credit losses: borrowers can default, and recovery can be slow and partial.
- Exit dependence: private equity gains are realised only when a buyer or a listing appears.
- Model-based valuations: unlisted holdings do not have daily prices.
Deciding between private markets and listed strategies?
We can walk you through how a Category III AIF differs in horizon, liquidity and tax. No obligation. Talk to us. Compare all categories.
Related reading
AIF categories explained · Category I AIF · Category III AIF · AIF vs PMS
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. Trilithon does not offer Category II AIFs. 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.
Category 2 AIF questions answered
What is a Category 2 AIF?
A Category 2 AIF is a SEBI-registered pooled fund that does not fall under Category I or III and does not borrow beyond day-to-day operational needs. It includes private equity, debt, real estate and fund-of-funds strategies and is close-ended.
Why is Category 2 called a residual category?
Because SEBI defines it by exclusion: any AIF that is neither Category I nor Category III, and that does not use leverage beyond operations, goes here.
What is the difference between a private equity AIF and a debt AIF?
A private equity AIF buys ownership in companies and earns when it sells. A debt AIF lends to companies and earns interest, with principal returned at maturity. Both are Category II.
Can a Category 2 AIF use hedging or leverage?
Hedging is allowed within SEBI guidelines. Borrowing is limited to day-to-day operational needs. Only Category III may use leverage as part of its strategy.
How long do Category 2 funds run?
At least three years, and extensions are possible with unit-holder approval. Private equity and credit funds are commonly set up for several years plus extension options, as stated in each fund’s PPM.
What is the difference between Category 2 and Category 3 AIF?
Category II holds mostly unlisted equity and loans in a locked, close-ended structure and passes income through to investors. Category III runs listed-market strategies, may use derivatives and leverage within SEBI limits, can be open-ended, and is taxed at the fund level.
Who can invest in a Category 2 AIF, and with how much?
Resident HNIs, NRIs, corporates, trusts, family offices and institutions that meet the fund’s terms, with a minimum commitment of ₹1 crore.
Are Category 2 AIF returns guaranteed?
No. Equity can lose value and borrowers can default. SEBI registration does not guarantee returns, and the entire principal can be lost.