What Investors Can Learn from Venture Capital Funds, Real Estate and More

Our discussion about the difference between private funds and mutual funds continues with an expanded breakdown of some common private fund options. There are multiple investment funds to choose from as an investor. Each investment type is uniquely different and has a different scope of risk. From the classic venture capital funds to private equity funds and the growing popularity of real estate investments—learning about these could help you reach your financial goals.

Venture Capital

Venture capital (VC) funds can be likened to the expression that “one plants many seeds with the expectation only a few will grow.” When compared with private equity (PE) funds, VC funds tend to hold more portfolio investments, thus the expression. With the higher risk there comes a higher expectation for reward and returns. VC funds focus on early-stage growth companies that need capital to grow the business—the risk the VC funds take is that the capital utilized may or may not make the operating company succeed at reaching its goals. VC investors tend to be more hands-on with management or may make decisions on key senior management positions in the company. Many of the companies that VC funds invest in are not able to get traditional bank financing and have few options for getting the capital necessary to grow their company to the next level. Since VC funds tend to be a bit smaller than PE funds, I’ve seen a number of approaches that managers have taken to raise capital for deals. Instead of setting up a fund in a “blind pool” structure where investors pool their money and leave it to the manager to make the investment decisions

Real Estate Investment Funds

Real estate investment funds have been growing in popularity in many ways. From the exchange-listed Real Estate Investment Trusts (REITs) to private funds and even crowdfunding programs, real estate investment is here to stay. People like to invest in something they can see and touch. Real estate fund managers can structure their funds in a way that best suits the type of real estate transactions they will do. Managers who are buying a large number of residential properties for flipping or rental can structure their fund in more of a traditional hedge fund format to accommodate investors coming in and out of the fund on a periodic basis. (The periodic cash flow in such a fund can accommodate this.) Investing in real estate presents some unique considerations, especially when it comes to foreign investors, tax-exempt investors like IRAs, or fund structures created to have these two types of investors participate in US real estate activities.

Fund of Funds

Fund of fund (FoF) vehicles were created to give investors the ability to participate in the alternative fund space and get diversification. Even for many high net worth individuals, the minimum investment requirements for many managers would prohibit them from making investments in multiple funds. A fund of funds enables the investors to invest one amount that will be commingled with the capital from many other investors and spread their risk or exposure among a number of hedge fund managers in a variety of strategies. For the investor who wants hedge funds but not to “put their eggs in one basket,” a fund of funds is a great way to go. The other benefit that FoF managers provide, not only to the high net worth investor who wants hedge fund exposure plus diversification but also to large institutional type investors, is leveraging their analysts to do all the heavy lifting on vetting the underlying hedge funds. Identifying and performing due diligence on these hedge fund managers requires a tremendous commitment of resources, in both time and expertise.

 

Next up we will look at common structures and considerations for alternative investment funds. That includes: limited partnerships, offshore funds and fund operation.

 



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