Equity is one of the largest asset classes globally. Usually when people think of equities, they think of equity shares of companies. However, the definition of equity can be used in Real Estate as well. In the case of company shares, equities are divided into 2 broad classes: Public Equity and Private Equity. Further, investors can either manage funds on their own or let an advisor manage them in return for a fee. From the investor’s perspective, the objective should be to maximize net returns. Net Returns are defined as the returns after all costs, that is, after advisory fees, brokerage, and taxes.
Before we deep dive into equity lets first understand what it is. At a fundamental level, equity means a share in the profit of a company. So, someone who owns, say 10% equity in a company, owns 10% of net profits of that company. If someone owns 1 share of a company and then company has a total of 100 shares, then the person owns 1% (1 out of 100) in the company’s equity. As company’s grow larger they raise capital to continue expansion. Some of this capital is raised by giving a capital provider some ownership – by giving them some equity shares – in that company.
Private Equity refers to equity shares of a company that is privately held. These companies are usually riskier to invest as compared to listed companies as one cannot enter and exit at will. In the case of listed shares, an investor can purchase or sell shares at the stock exchange. Because of the additional risk, these investments have also generated significant returns. These investments are usually possible only for High Net Worth individuals as the minimum investment amounts are quite large. The following are the ways in which equity investors can take exposure to equities of privately held companies.
1) Investing in startups and VC funds
Investing in startups is actually treated as a different asset class called Angel investing. While technically a startup is a private company, angel investing is an asset class in itself and we can learn more about it here. A VC fund is a pool of capital that is managed by an expert and focusses on investing in startup companies. One can invest in startups directly but investing in VC funds require a certain minimum amount making them accessible usually only to HNIs.
2) Investing in unlisted shares of large companies
Many companies have several equity investors even before going public. This could be for various reasons, for example – early angel investors have sold their shares to different people. These companies can be lucrative investment opportunities specially if these companies are near at pre-IPO stage. There are distributors who focus on selling of unlisted shares.
3) Investing in Private Equity funds
Similar to mutual funds, Private Equity funds are pools of capital that are managed by experts. However, unlike Mutual funds, the capital commitment to a PE fund is not made in one tranche but in several tranches based on when the Private Equity fund calls capital. This structure is similar to Hedge Funds described above. These are usually accessible to HNIs.
4) Investing in Fund of Funds (“FoF”)
Fund of Funds invest in a pool of different VC or PE funds. The advantage with this approach is that the risk is diversified across different investment managers. While this diversification may reduce the potential returns as well because of the additional layer of fees brought on by the FoF, the advantage it brings is a professional management and due diligence towards investing in fund managers. In addition, the minimum investment size of investment in FoF is lower than that in a VC or PE fund thereby providing investors access to some VC or PE funds that they otherwise would not have access to.
Individuals therefore have a choice between managing their equity investments themselves or using a combination of the above methods. Letting experts manage the funds results in fees but the investor funds are the professionally managed and can result in better risk-reward dynamics.
Disclaimer: Vitspan does not provide any investment related, tax related or financial advice. The information presented is done so without considering the investment objectives, risk profile, or economic circumstances of any reader or investor. The information presented may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the potential loss of principal. Please consult your financial advisor prior to making investment related decisions.