Wealthy Investors Accelerate Shift to Category III AIFs as Volatility Spurs Demand for Hedge-Style Strategies
A significant shift to Category III AIFs is unfolding across India’s wealth landscape, with high-net-worth and ultra-high-net-worth individuals increasingly moving their capital away from traditional long-only investment vehicles such as mutual funds (MFs) and portfolio management services (PMS). Volatile equity markets, muted returns and the search for lower-volatility strategies are reshaping asset allocation trends among India’s affluent investors.
According to SEBI data reviewed by industry sources, Category III AIFs mobilised ₹62,471 crore in the first half of FY26, reaching nearly 70 percent of FY25’s full-year inflows of ₹89,587 crore. This sharp acceleration reflects how investors are chasing hedge-style strategies like long-short, quant and absolute-return funds to protect against market drawdowns and generate more predictable outcomes.
Muted Market Performance Triggers Shift to Category III AIFs
The dominant trigger behind the shift to Category III AIFs is the market backdrop itself. Over the past year, benchmark indices have delivered flat to negative returns, and midcap and smallcap segments have witnessed bouts of sharp correction.
“HNIs and ultra-HNIs are reallocating meaningfully towards Category III AIFs because public market returns have been muted,” said Ajay Vora, Head of Equities at Nuvama Asset Management. “When markets look slightly overpriced and forward returns seem subdued, investors naturally shift toward products that offer better visibility and lower volatility.”
SEBI data reveals that quarter-on-quarter commitments into Category III strategies have climbed through the first half of FY26, highlighting a growing urgency among wealthy investors to hedge market exposure.
Wealth managers confirm that after nearly a year of sideways markets, clients have begun trimming allocations toward mutual funds and PMS offerings, favouring long-short or hedge-like structures to stabilise portfolios.
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Hybrid, Quant and Absolute-Return Funds Drive the New Wave of Adoption
A growing number of innovative strategies within the Category III segment are also powering this shift. Hybrid funds—combining listed equities with unlisted or pre-IPO exposure—have gained significant traction, according to Vora.
“These 70:30 or 51:49 structures offer stability because the unlisted component doesn’t move daily,” he said. “Cat-III also allows thematic and structural plays that MFs or PMS often cannot access.”
However, the strongest inflows are going into absolute-return funds, marketed as “fixed-income-plus-plus” products that offer predictable yields with limited volatility.
“When markets are volatile and sideways, these strategies can deliver 8–10% post-fees, post-tax,” Vora noted, adding that family offices and corporate treasuries have become major contributors to the inflows.
These demand trends underscore how the shift to Category III AIFs is being driven not just by market uncertainty but by the appeal of alternative strategies that promise controlled risk and consistent returns.
Growing Awareness and Financial Sophistication Boost Investor Confidence
Another key driver of the rapid shift to Category III AIFs is increasing investor awareness. Indian HNIs are now more familiar with hedge structures, long-short frameworks, and the concept of risk-adjusted returns.
Vaibhav Sanghavi, CEO of ASK Hedge Solutions, said investors are becoming more informed and data-driven.
“It is heartening to see clients talking about standard deviation, drawdowns and tail risks,” Sanghavi said. “This shows an evolved understanding of how alternative strategies can stabilise portfolios.”
He added that this trend is structural, not cyclical: “Portfolios in India have much lower allocation to these strategies versus global standards. What we are seeing now is the early phase of a long-term realignment.”
Many managers have now built 2–4 year track records, improving comfort levels among wealthy investors who once viewed hedge-style structures as complex or opaque.
Wealthy Investors Trim Mutual Funds and PMS as AIFs Offer Greater Flexibility
While mutual funds and PMS remain central to domestic equity flows, a clear subset of investors is diversifying towards differentiated models. Category III AIFs allow leverage, long-short exposure, and derivative-based hedging, which traditional equity products cannot offer.
“Category III funds, with their ability to go long on winners and short on underperformers, add tremendous value,” Sanghavi said. “They help mitigate risk and generate alpha using structured processes.”
This flexibility has been particularly appealing in a year where major indices have moved sideways and equity beta has failed to generate meaningful returns.
Taxation Remains a Barrier to Broader Adoption
Despite strong traction, taxation continues to be a sticking point in the shift to Category III AIFs.
Sanghavi emphasised that derivative taxation remains challenging for AIF structures, limiting wider acceptance.
The industry has consistently demanded pass-through taxation, which would bring Category III AIFs on par with other regulated vehicles and potentially open the gates for greater domestic and offshore participation.
Outlook: Structural Shift Toward Lower-Volatility, High-Visibility Strategies
Wealth managers believe the demand for Category III AIFs will remain strong even if equity markets rebound in the coming quarters. Hybrid models, absolute-return products, and quant-driven long-short strategies are expected to draw continued inflows due to their ability to deliver stability in uncertain macro environments.
“As markets normalise, some allocation may return to long-only equity,” said Vora. “But the core demand for lower-volatility, risk-adjusted, and yield-oriented Cat-III strategies is here to stay.”
With wealthy investors increasingly prioritising resilience over high-beta performance, the shift to Category III AIFs marks one of the most significant structural changes in India’s investment landscape.
