The Pros and Cons of Investing in a Private Equity Fund
July 19, 2022
Investing in private companies isn't easily possible for most retail investors, but a private equity real estate fund makes it easier to invest in companies and earn a portion of their profits. Like any investment, investing in a private equity fund has pros and cons.
Here's what you should know.
What Is a Private Equity Fund
A private equity fund is an investment fund in one or more private businesses. The private equity firm holds the investments, but the funds come from a pool of investors. Some private equity firms invest and buy, improve and then sell businesses, and others buy and hold.
A private equity fund lasts for the long term, usually ten years, and requires a high investment that investors must be able to tie up for the duration of the investment.
Role of a Private Equity Fund Administrator
Private equity fund administration handles the day-to-day operations of running a private equity firm. They choose the investments, manage them, and eventually sell the businesses to give investors a return on their investment.
Private Equity Fund Structuring
Private equity funds have a small window of opportunity to raise funds. Once the window closes, the fund cannot raise any more funds. Most private equity funding structures are LLC or LP (Limited Partners).
There are two main groups in a private equity fund structure:
- The sponsor (the party responsible for gathering the funds and managing the investments)
- The investors (the parties providing the funds)
The sponsor includes the general partner or the person in charge of all financial and investment decisions and the management company, which is who the general partner answers to for the investment.
The private equity investing fund starts with the sponsor reaching out to sources within its network to raise capital. Each investor that contributes will receive a partnership agreement that states the terms of the investment, including the timeline of the investment (when they'll receive a return on their investment).
Pros and Cons of Investing in a Private Equity Fund
Like any investment, there are pros and cons of investing in private equity investments. Understanding both sides can help you determine if this is the best use of your funds or if you should choose a different asset class.
Pros of Private Equity Investing
With private equity investments, you don't have to do anything to earn a return on your investment. Your role in the process is to choose the private equity funds that meet your risk tolerance, timeline, and financial goals. Once you invest your capital, you sit back and watch your investment perform. The sponsor is responsible for managing the businesses, improving them, and potentially selling them for a profit.
Opportunity for Diversification
When you invest in a private equity fund investment, you have the opportunity to have a diversified portfolio. In addition, since most sponsors will own multiple businesses within one portfolio, you can offset your losses by having multiple opportunities for capital gains.
Not putting all your eggs in one basket is the best way to maximize your chances of growth capital. Even if one or two businesses don't perform as hoped, others within the portfolio can compensate for it.
Most private equity firms require investors to commit their funds for ten years. This gives the fund a chance to turn a profit even if any of the businesses hit a rough spot. Longer-term investments usually have a higher rate of return because they have time to overcome any negative turns the fund takes throughout the timeline.
Private equity funds have an average return of 10.48% over the last 20-year period. This is often higher than the typical stock exchange returns, giving institutional and retail investors another avenue to earn money.
Cons of Private Equity Investing
Like any investment, there are risks with private equity funds. Since you can't predict which businesses the sponsor will add, nor do you have a say in it, there's a risk. You may disagree with the businesses the sponsor adds to the portfolio, or the sponsor could make a bad decision, leaving the fund with a loss.
Higher Minimum Investment
The investment requirement for private equity funds is high. Even though they pool funds from multiple investors, many private equity firms require investments of $250,000 or higher, sometimes in the millions. This means private equity investors are usually only high-net-worth individuals.
There's not as much transparency as most investors would hope with private equity funds. You'll know the basic information about the fund, but each management team offers a different level of transparency. This could mean you don't know what goes on behind the scenes with an investment that holds many of your assets.
Questions to Ask Before Investing in a Private Equity Fund
Before you invest in a private equity fund, ask these questions to get as much transparency as possible for private equity fund investors.
- What type of assets will the fund invest in?
- How many funds does the firm sponsor?
- What is the investment strategy?
- What is the minimum investment requirement?
- How many investors are you hoping to attract?
- What stage are the proposed businesses in before you choose them?
Private Equity Fund Investments FAQ
Hedge Fund vs Private Equity: What's the Difference?
When comparing a hedge fund vs private equity investments, you'll notice that they are both targeted to high net worth investors, requiring at least $250,000 invested. Hedge funds, though, are short-term investments. Their goal is to obtain high and quick profits for investors. On the other hand, private equity funds are long-term investments that last as long as ten years. Therefore, they look for slow and steady returns.
Mutual Fund vs Private Equity: What's the Difference?
Mutual funds and private equity funds both invest in companies; however, mutual funds focus on publicly traded companies. As we've established, private equity funds focus on privately owned companies. Private equity funds are not publicly traded, and mutual funds are publicly traded.
What Is a Private Equity Firm?
A private equity firm is a company that uses its own funds or funds gathered by investors to invest in private businesses. They are not public companies and usually only cater to high-net-worth individuals.
The Bottom Line
Private equity funds can be a good option if you're looking for a way to invest your money elsewhere other than the stock exchange. While there are pros and cons of investing in a private equity fund, it can be an excellent way to diversify your portfolio further, whether as a part of your pension funds or a standard investment. Learn more by signing up and visiting our blog.
This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security which can only be made through official documents such as a private placement memorandum or a prospectus. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Neither Concreit nor any of its affiliates provides tax advice or investment recommendations and do not represent in any manner that the outcomes described herein or on the Site will result in any particular investment or tax consequence.Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Concreit does not guarantee its accuracy.