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Alternative investment funds (AIFs) that deploy long-short strategies have approached the market regulator seeking an increase in their leverage ability to gain an advantage over newly launched specialized investment funds (SIFs) that are said to be eroding their collective asset base.

SIFs, a category of mutual funds that operate long-short strategies, were launched in April 2025 and enjoy a tax advantage over their rival category III AIFs. This has led to the closure of some AIF long-short funds.

A long-short strategy is typically adopted by hedge funds to protect against risk by taking long and short positions in stocks.

While tweaking the tax structure is not in their hands, a group representing AIFs wants the Securities and Exchange Board of India (Sebi) to increase their leverage ability, which is currently limited to 2x. If an AIF has ₹100 crore of assets, it can take an overall exposure of ₹200 crore in the markets. SIFs are not allowed to leverage their assets.

“The Indian Venture and Alternate Capital Association (IVCA) is again in talks with Sebi to push for a higher leverage for AIFs. The higher leverage can then compensate for the loss in returns due to taxation,” said a person with direct knowledge of the matter.

The IVCA had initially suggested increasing the leverage when the consultation paper on SIFs came out in 2024. The matter was also discussed at the Sebi Alternative Investment Policy Advisory Committee (AIPAC) last quarter, said the second person aware of the developments.

“Category III AIFs were asked at the time to make a committee and submit their recommendations to Sebi. The regulator will ensure that customers are aware of the amount being leveraged and that AIFs will do a risk analysis before leveraging huge sums,” the second person said.

Emails sent to Sebi and IVCA remained unanswered till press time.

SIFs managed assets of ₹9,711 crore in February, according to the Association of Mutual Funds of India (Amfi). While data for long-short AIF assets isn’t available publicly, it would not exceed ₹5,000 crore, said the first person.

Assets in the long-short AIF category declined after two companies wound up their long-short fund business due to the tax disadvantage. Avendus Capital closed two long-short AIF funds with assets worth ₹3,000 crore in January 2025, Mint reported earlier.

Tata AMC shut its AIF business, which had two funds, in February 2026, citing the same reasons, Mint reported earlier. The Tata funds had ₹1,830 crore of assets when they closed, an official said on Wednesday.

The returns of long-short AIFs are taxed at 39% at the fund level, while SIF returns are taxed at 12.5%, if held for more than 12 months.

SIFs offer superior tax efficiency, being taxed like mutual funds, whereas category III AIFs can face higher effective taxation at the fund level, which impacts post-tax returns, said Chinmay Sathe, chief investment officer–SIF, at The Wealth Company Mutual Fund.

“AIFs can generate higher gross returns than SIFs due to leverage. However, the advantage narrows on a net basis because SIFs enjoy mutual fund-like taxation while category III AIFs are taxed higher,” said Puneet Sharma, chief executive officer at Whitespace Alpha, which manages a long-short AIF. “On a net basis, a long-short AIF will then generate at least 50-100 basis points alpha higher than an SIF.”

If leverage for AIFs is increased beyond 2x, the return gap may widen, with AIFs delivering significantly higher net returns than SIFs, Sharma added.

Another reason for the growing interest in SIFs is the significantly lower entry barrier: ₹10 lakh compared with ₹1 crore for AIFs.

According to Bhautik Ambani, chief executive officer at Alphagrep Investment Management, globally, there is no limit on leverage by hedge funds.

“The asset manager just has to mention the nitty-gritty of the leverage in its private placement memorandum—the investors can then decide if they want to choose it or not,” Ambani said.

Even GIFT City category III AIFs do not have a cap on leverage, he added.

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