The decision will help make available more funds to start-ups, early stage ventures, small and medium enterprises (SMEs), which are generally considered as high risk investments.
Official sources said the Cabinet has given its approval for foreign investments in AIFs that are set up under Sebi regulations and would widen the avenues for overseas entities to put in their money.
Finance Minister Arun Jaitley announced in this year's Budget that foreign investors would also be allowed to invest in the AIFs.
The move would also reduce the pressure on the banking system to which the infrastructure sector looks for funding needs, they added.
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According to official sources, uncertainty in investors mind would be removed with the introduction of a clear cut written policy, which would not only improve the investment environment but also induce development activities.
Now, foreign investments would be allowed in AIFs that are established as registered trust, structured as incorporated company or limited liability partnership.
AIFs -- which include private equity, venture capital and hedge funds -- are regulated by Sebi, but the Foreign Exchange Management regulations are governed by the RBI.