AIF returns explained: Why high alpha may exist on paper, not in cash returned to investors

Alternative Investment Funds have delivered an average alpha of 9% over the Sensex, but most of that exists only in valuations, not in cash returned to investors. Here's what to look out for before you commit a crore. For India's wealthy investors, Alternative Investment Funds (AIFs) have quietly moved from the fringes of portfolio construction to the mainstream. In a short period of time, they have evolved into a Rs.16 lakh crore opportunity, growing at a 30.7% compounded annual growth rate between FY21 and the first half of FY26. The minimum investment required in an AIF in India is Rs.1 crore per investor. Income Tax Guide Income Tax Union Budget FY 2026-27 LiveIncome Tax Slabs FY 2025-26Income Tax Calculator 2025 Returns from AIFs are largely backended; your money is locked in for years while the fund builds and exits positions, with actual cash coming back to you only when the fund manager successfully sells investments through Initial Public Offers (IPO), mergers, or secondary transactions. High net worth individual (HNI) investors are chasing something that traditional markets struggle to consistently deliver -- alpha. Data from a Crisil-Oister benchmarking report released in February show that, across multiple benchmarking cycles, unlisted equity AIFs have generated an average alpha of around 8.7% relative to the Sensex Total Return Index (TRI). Alpha is the excess return an investment generates over its benchmark index after adjusting for risk. At first glance, this looks like a compelling proposition. But beneath the headline returns lies a question that too few investors think to ask: how much of this money has actually come back to me? Is the alpha real?The alpha is real, audited and reported by CRISIL. But a significant share of these AIF returns are yet to be realised. Rohit Bhayana, Co-Founder of Oister Global, says: "Returns mostly are unrealised. That's the reality." He adds that approximately 80% of AIFs have now started some form of cash distributions. But the larger part of reported alpha, he acknowledges, is still driven by markups and interim valuations rather than actual cash exits. Another reality is that AIF distributions (DPI) are increasing at a 65% CAGR (compounded annual growth rate), while commitments are growing at 28% CAGR over the last three years. Shobhit Mathur, Co-Founder of Ionic Wealth, is more precise about the proportions. In early- and mid-life funds, he estimates that 60-80% of gains are typically marked to market based on the latest funding rounds or internal assessments. Growth and late-stage funds tend to have 30-60% unrealised, while private credit funds are largely the exception, as they are realised due to regular cash yields. To understand why this matters, it helps to know how AIFs measure performance. The industry standard is IRR, or Internal Rate of Return, a metric that accounts not just for how much a fund earns, but for when that money actually flows back to investors. The faster capital is returned, the higher the IRR. That time-sensitivity makes it a more sophisticated measure than a simple percentage gain. "A high IRR with low distributions is often a red flag," says Mathur. Most funds do publish net returns after expenses and carry, but the real-world experience can still fall short of the marketed figure. Understanding the metricsTo make sense of AIF performance, investors need to understand three core metrics. IRR is the annualised rate of return that accounts for the timing of all cash flows, both capital drawn down and distributions made. MOIC, or Multiple on Invested Capital, indicates how many times an investor's original investment has grown in value. A MOIC of 2x means the fund has generated twice the invested capital in total value, whether realised or not. DPI, or Distribution to Paid- In Capital, is the metric that tells you how much actual cash has been returned for every rupee invested, the numerator being cash out and the denominator being cash in. As per Crisil data, of the 170 schemes analysed in the March 2025 benchmarking cycle, 142 have made distributions to investors. Those in the top quartile show a maximum DPI of approximately 5.03 times and a minimum of around 1.01 times. As many as 60 schemes within the aggregated benchmark have returned at least 50% of the total capital contributions, while 47 have returned at least 75%. On average, these schemes have taken around 6.5 years to return 75% of contributed capital. The whole truthIRR becomes a more reliable indicator of actual performance only after the sixth or seventh year of a fund's life, when a meaningful portion of the portfolio has been deployed, exited, or entered the harvesting phase. "Before that, high paper gains in the early stages of a fund can inflate the IRR in ways that do not sustain as the portfolio matures," says Mathur. According to Bhayana, looking at only IRR is like touching one part of an elephant and concluding it is a pillar. Touching only MOIC is like concluding it is a rope. Touching only the DPI is like concluding it is a trunk. "You touch all of them together, you get the comprehensive picture," he says. A useful practical benchmark: in the top quartile of India's venture capital (VC) and private equity (PE) funds, Bhayana says DPI has already crossed 2 times, meaning for every rupee invested, two rupees of cash have been returned. That cohort is also the one delivering the most credible outperformance over public markets, and the median alpha of the full benchmark is already 8-9%, meaning the top quartile is substantially ahead of even that. Show me the moneyThe timeline for receiving distributions can vary depending on the stage of the fund, making it an important consideration for investors when they commit capital. Dev Piyush Rakhecha, Founder of Rakhecha Finserv, mutual fund distributor and wealth manager, breaks it into three buckets. "For startup and angel investing (typically Category I AIFs), the fund tenure is 8-10 years, and the first meaningful cash flows should not be expected before the fourth year at the earliest, with distributions continuing through the tenth year. For mid-stage funds, distributions typically begin around year three and end by year six or seven. For late-stage and pre-IPO funds, the window can be much shorter, anywhere from less than one year to four years." The late-stage category has attracted the most investor interest precisely because the liquidity cycle is more visible. These funds target companies planning an IPO in the next 6-18 months, aiming to capture the valuation arbitrage that has historically existed between private and public market pricing, often estimated at 30-50% by market participants. Mathur flags the structural risk that many investors overlook: while a fund may have a stated tenure of seven to ten years, extensions and delayed exits can stretch the actual holding period to a decade or more. "Many investors underestimate the true holding period," he says. Fund managers, he notes, want portfolio winners to run longer to improve the overall performance of the fund. Top performersNot all AIF categories deliver equal cash outcomes. Private credit AIFs offer the most predictable returns, 12-14% for performing credit and 16-18% for special credit situations, with regular quarterly distributions. These are fixed-income instruments in structure and behaviour, fundamentally different from equity AIFs. Secondary funds have also performed well. By entering late in the cycle, when failure risk is negligible, and exit timelines are more visible, they offer a cleaner return profile. Oister Global's analysis of around 30 growth-stage companies that went public over four years found a median return of approximately 26% for investors who entered two-three years before listing. Early-stage venture capital is a different story, with high dispersion, significant write-off risk, and longer-than-expected liquidity timelines. Many early-stage investors have had to route exits through secondary funds and continuity vehicles rather than direct IPOs or acquisitions. Category III AIFs, hedge funds, and listed equity strategies sit apart from the rest. They invest in listed securities, offer continuous mark-to-market valuations, and, in many cases, provide monthly liquidity. Multi-adviser Category III structures, combining four to five boutique managers with low style overlap, are emerging as an option for HNIs who want professional alpha without a decade-long lock-in. Distribution trends Distributions to paid-in capital (DPI) measures the ratio of cumulative distributions made by the fund to the total capital contributed by investors. The right fitGiven the wide gap between top- and bottom-quartile managers, fund manager selection is everything. Rakhecha says investors should focus more on a fund manager's exit track record rather than just their investments. "If a manager hasn't successfully exited investments before, that's the most important factor investors should pay attention to," he says. In private markets, even a loss-making exit requires a willing buyer; a manager who has navigated exits across market cycles is categorically different from one who has only deployed capital. Bhayana describes a six-stage due diligence process at Oister that mirrors institutional practice globally: prioritising fund managers with a strong track record across the investment cycle and achieving successful exits; quartile performance; distribution of performance of investee companies; strength and resilience of the fund managers' franchise; replicating success; and robust governance. For Category II funds, Mathur recommends analysing past exits by timeline, multiples achieved, and exit route. For Category III listed-equity AIFs, the equivalent lens is the manager's discipline on profit- booking, cash calls in stretched markets, and rebalancing rigour. In private markets, manager selection often matters more than asset allocation. The dispersion in returns between top and bottom quartile managers is far wider than across asset classes. "A more evolved approach removes the need to pick a single manager. Multimanager Cat III AIFs combine 4-5 lowcorrelation, low-overlap managers with a rules-based overlay, delivering skill, true diversification, and dynamic risk management in one structure," says Mathur. The tax pictureThe tax treatment of AIFs differs meaningfully by category. "Category I and Category II AIFs operate under a pass-through structure for most income types. Securities held by these funds are always treated as capital assets, regardless of the fund's intent, which means gains are taxed as capital gains in the hands of investors rather than as business income at the fund level," says Naveen Wadhwa, Vice-President at Taxmann. "Critically, even if income is not actually distributed during the year, it is deemed to have been credited to investors proportionately, a provision that can create tax liability in years when no cash has been received," Wadhwa adds. Category III AIFs do not benefit from pass-through status. All income, capital gains, business income, or otherwise, is taxed at the fund level based on the fund's legal structure, most commonly a trust. Investors are taxed only on distributions received, not on income as it accrues. Certain Category III AIFs established in International Financial Services Centres and catering to non-resident investors may qualify for income exemptions under specific conditions. In contrast, mutual funds in India are taxed on a distribution-based model, where investors are liable to pay tax only when they redeem units or receive income, unlike Category I and II AIFs where tax can arise on accrued income even without actual cash flows. The takeawayThe alpha over public markets is real, and for funds that have completed their cycles, the wealth creation has been genuine. But the industry is still young, and much of its reported performance remains in paper valuations rather than cash in hand. True wealth creation will be fully validated only as exits materialise over the coming years. For investors navigating this space, the practical guidance from experienced practitioners points in a consistent direction: look at DPI alongside IRR; understand the realistic timeline for distributions given the fund stage; scrutinise the fund manager's record of exits specifically rather than just investments made; ensure the locked-in capital represents a portion of a larger, liquid portfolio that can absorb years of illiquidity without disruption; and do not enter a fund because the presentation looked compelling.