Introduction
Why do most investors misunderstand lock-in periods in AIFs?
One of the most asked questions from investors is
“How soon can I withdraw my sum?”
This may sound normal, but liquidity isn’t always a good idea. Patience delivers the results, especially in the case of equity investments. Hence, it is one of the most structural reasons investment strategies work out in the first place.
Category I and II AIFs are mandated by SEBI to be close-ended, with a minimum tenure of three years, calculated from the date the fund makes its final closing. Category III can be open or close-ended.
Let’s get through the investment tenure of the Lock-ins
- Investment period — typically the first 2-3 years, where capital is actually deployed into portfolio companies or assets
- Holding / harvest period — where investments mature and are actively managed toward an exit
- Exit window — where positions are sold, IPO’d, or otherwise monetised and proceeds distributed
Tenure is the total runway the fund manager needs to take capital through all three phases without being forced to compress any of them.
Hard lock-in, soft lock-in, and where exit load fits
Hard lock-in is a complete restriction on withdrawal. Redemption is not allowed under any circumstance, at any cost, during the period. This is the form of lock-in which SEBI prescribes for Category I and II AIFs which have a close-end structure where there is no provision for redemption during the period except for a secondary transfer with the permission of the manager.
Unlike hard lock-in, a soft lock-in allows redemption but the investor has to pay a fee known as an exit load for withdrawing from the scheme within the specified period.
An exit load can be imposed only if the scheme has provisions for redemption in the first place. In a hard lock-in, redemption cannot be made within a specified period so no exit load can be charged. In soft lock-in schemes, the scheme has to allow periodic redemptions within a minimum holding period and if you choose to redeem before that period, you are subject to an exit load which is usually around 1–3%.
Lock-in isn’t uniform across AIF categories either
- Category I and II — hard lock-in by regulation. Structured as closed-end, with a minimum of 3-year holding period, and no redemption option available during the period. The only way out before maturity is through manager-approved secondary transfer.
- Category III, closed-ended — the same hard lock-in mechanics as Category I and II, with tenure typically running 3 to 7 years depending on strategy.
- Category III, open-ended — this is where soft lock-in shows up. These funds often run periodic subscription and redemption windows, with a soft lock-in of roughly one to three years and an exit load for redemptions made before that period is up.
What should investors note here?
Before assuming that your money is “locked for X years,” find out what kind of lock-in is specified in your PPM. There can be a hard lock-in as well as a soft lock-in with a three-year exit load period that are referred to as “3-year lock-in” in a casual way. The implications of those two types of lock-in are entirely different.
Why is it necessary?
Private assets cannot be sold overnight: Illiquid assets can’t be sold on short notice without a discount. If an AIF holding SME or pre-IPO positions had to honour redemptions on demand, it would have two options: hold a permanent cash buffer that drags on returns, or sell good positions early at a bad price to fund the exit. Lock-in removes that choice entirely.
Value creation demands time: The businesses that AIFs invest in are often still growing.
A pre-IPO company, for example, may need several years to expand its operations, improve profitability, strengthen governance, and prepare for a successful listing. Similarly, a private equity investment may require time for operational improvements before it reaches its full potential.
If capital could be withdrawn midway through this journey, the fund might be forced to exit before the investment has had the opportunity to create its intended value.
Simply put, private market investing is a long-term process, and the investment horizon should match the time needed for that value to be realised.
The Alignment problem: One of the lesser-known reassuring facts in the AIF framework is that the fund manager or sponsor is also required to invest their own money in the fund.
Under SEBI regulations, the sponsor or fund manager must maintain a continuing investment in the AIF, typically 2.5% of the corpus or ₹5 crore, whichever is lower (subject to the applicable category and regulations).
More importantly, their investment remains locked in alongside the investors’ capital. Their returns depend on the same investment outcomes, and they cannot simply exit early if markets become volatile.
This creates an important alignment of interests: the fund manager succeeds only when the investors succeed. It reinforces the idea that the manager is investing alongside investors, not merely managing their capital.
Liquidity risk is not investment risk — and conflating them is the costliest mistake
When evaluating an AIF, many investors focus on a single idea of risk. But there are two separate questions you should ask:
- Can I lose money? (investment risk)
- Can I access my money whenever I want? (liquidity risk)
Investment risk is the possibility that your investment may not deliver the expected returns. A portfolio company may fail to grow, market conditions may change, or the fund may exit its investments at lower-than-expected valuations. This is the risk every investor consciously takes, and it is managed through careful investment selection, due diligence, diversification, and the fund manager’s expertise.
Liquidity risk, on the other hand, is about when you can access your money. Even if the fund is meeting its objectives and the underlying investments are doing well, your capital may remain locked in until the fund reaches the appropriate stage to exit those investments. That isn’t a sign that the fund is underperforming; it’s simply how long-term private market investing is designed to work.
This distinction matters because many investors assume that if their money is locked in, the investment must also be riskier. But that isn’t necessarily true.
A Category II AIF may have a well-researched investment strategy, strong governance, and high-quality assets, making the investment risk relatively low. Yet, it can still have high liquidity risk simply because your capital is committed for the life of the fund.
On the other hand, a listed stock is highly liquid—you can usually sell it on any trading day. But that doesn’t make it a safer investment. If the company performs poorly, the value of your investment can still decline significantly.
In simple terms, the ability to exit quickly does not determine how risky an investment is. Likewise, a lock-in period does not automatically make an investment unsafe.
What to actually ask before you commit?
Since lock-in is permanent for the duration you agree to, the diligence should happen before signing, not after.
On liquidity risk:
- Can I genuinely go without this capital for the full stated tenure?
- Does the PPM permit secondary transfer, and on what terms?
- Are the fund’s units eligible for exchange listing, and has the fund manager indicated intent to list?
On investment risk:
- What does the distribution policy say — proceeds returned as realised, or reinvested?
- Has the manager’s continuing interest actually been contributed, and is it disclosed?
- What’s the fund’s stated plan for the exit window — timeline, not just intent?
None of these changes the fact that your capital is locked in. What they change is whether you understand ‘what you’ve agreed to’.
Lock-in isn’t the price you pay to access illiquid, high-return strategies. It’s the mechanism that makes those strategies deliverable in the first place. An AIF without lock-in wouldn’t be a better version of the same product; it would be a fundamentally different, weaker one, forced to hold cash it can’t deploy or sell assets it shouldn’t be selling.
