While the stock market and investing may seem like a relatively new part of the global economy, financial markets have actually been around for the better half of a millennium. The earliest stock markets showed up in Europe in the 1400s and even though records are sparse, it's generally agreed they originated in Belgium.
The US's own New York Stock Exchange (NYSE) began in the late 1700s, though the markets now have a much larger breadth and depth compared to those in centuries past. From private equity funds and hedge funds to mutual funds and more, there are now countless ways for today's investors to generate a profit through the many different types of investment fund structures available. In this article, we'll define and discuss the more prominent investment fund structures.
For smaller, more retail-focused investors, investments may seem to only operate within the public market. But as private equity dealmakers and fund managers know, there are plenty of opportunities in the public and private markets across private equity funds, real estate, and more.
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To form a private equity fund, a private equity firm, called a General Partner (GP), must find high-net-worth individuals, known as Limited Partners (LPs). The GP then collects the investors' often millions of dollars and creates a legal entity — the private equity fund — with which the GP acquires controlling portions of or even entire private companies. In some cases, the private equity fund will even take public companies private, which is known as reprivatization or delisting.
Nearly every private equity fund structure follows the same format. While the GPs source the LPs to provide capital for the fund, both parties have legal authority over it. However, only the private equity firm manages the fund's operation via dedicated fund managers, giving the LPs limited authority over the fund and its direction, including which companies become part of its portfolio.
That said, the fund itself is a legal entity and owns the companies within that portfolio. Private equity firms often manage multiple PE funds, each with its own investment thesis and goals for providing a return to its investors. Likewise, LPs may have provided capital for multiple private equity funds.
Check out our blog post for a deep dive into how private equity funds are structured, including the fees involved and a handy private equity fund structure diagram.
When discussing private equity funds, a common question may be how PE funds relate to private equity financing. Deals in mergers and acquisitions (M&A) take innumerable forms, as the transaction is very rarely a simple trade of ownership for cash.
However, most private equity financing structures fall into one of three categories:
Private companies are not the only entities that private equity firms purchase to make a return for their investors; real estate is also a popular choice. Private equity real estate funds are not to be confused with equity real estate investment trusts (REITs), which are publicly traded like company stocks.
While REITs generate revenue by charging rent on the properties the trusts buy, private equity real estate funds operate much more closely to a typical private equity fund structure. Only accredited investors can participate within the real estate private equity fund structure. Additionally, the fund generates a return after selling a property, rather than charging rent to tenants as with an REIT.
On the surface, a private equity fund's structure and a real estate private equity fund's structure are very similar. Both funds operate as the legal entities that own the companies or real estate properties within the portfolio that the private equity firm manages. Additionally, the LPs and GPs own the fund and make money through selling off the fund's owned entities.
However, while the GPs for a private equity fund generally provide between one and three percent of the fund's size with their own capital, fund managers for private equity real estate funds often provide much more — over 10% in some cases.
Both management and performance fees also differ between private equity funds and their real estate-focused cousins. Real estate private equity funds fees differ considerably from fund to fund, while many PE funds have fairly similar fees.
Another popular type of investment fund structure is a hedge fund. In fact, there are more than 30,000 hedge funds in existence today. These funds differ from private equity firms in many ways, though the primary difference is that hedge funds operate much more flexibly and invest in either public or private markets.
Additionally, while it can take many years for a private equity fund to provide a return to investors, hedge funds have frequent liquidity events based on the fund manager's specific view of the market. Tactics are usually chosen based on what will create the highest return in the shortest time frame.
Closed-end and open-end investment funds, most often used to describe mutual funds and exchange-traded funds (ETFs), are not types of fund structures on their own but rather refer to the operation of the funds they describe.
To this point, the funds we've discussed have largely been for institutional or accredited investors with a lot of capital at their disposal. Mutual funds, at a simplistic level, are similar to private equity funds: Mutual funds have investment portfolios run by fund managers, who have pooled the funds' investors' money together to purchase shares. One of the main differences, though, is that mutual funds exist to allow for share purchases that would otherwise be unavailable at lower investment levels.
Because of this, mutual funds are much more accessible to all investors and minimums may be only in the hundreds of dollars rather than hundreds of thousands. So, rather than purchase controlling shares, entire companies, or vast swaths of real estate, mutual fund managers often choose stocks and bonds as their investment vehicles. Most mutual funds are open-end, but some may be closed-end. Regardless, mutual funds are only traded once per day at the end of the day.
The most common types of mutual funds are money market, bond, stock, and target date funds, where each has its own preferred strategy and goal. For instance, target date mutual funds are a popular choice for retirement portfolios and pension funds, as they keep a "maturity date" in mind. The fund managers will alter the strategy to be higher risk when the fund is furthest from its maturity date and gradually lower risk as time goes on. There are also balanced mutual funds that are generally low- to medium-risk because of their incredibly diverse investment portfolio.
Last but not least, an exchange-traded fund (ETF) is perhaps the most individual investor-focused type of investment fund. ETFs are publicly traded, and rather than offer a particular company's stock or an individual commodity, they allow investors to purchase shares in a collection of assets.
Much like hedge funds, ETFs vary considerably among those available. Some focus on a particular type of asset, such as stocks or currencies, and others may instead focus on a particular industry. For individual investors, ETFs often have much lower fees compared to those incurred from buying each asset individually. However, as ETFs are still managed by a fund manager, more active funds may have higher fees because managers regularly change the fund's strategy.
As with mutual funds, most ETFs are open-end funds. However, ETFs are traded throughout the day. It's also important to note the available number of shares changes constantly as new shares are created and existing shares are redeemed to keep the ETF's price in line with the market.
From private equity funds vs. hedge funds and even mutual funds and ETFs, the many different types of investment fund structures mean investors of all kinds have plenty of opportunities to create a diverse portfolio. For institutional investors, however, private equity funds offer unique opportunities not available within the public market.
No matter your preferred investment vehicle, making smart decisions about when and what to invest in relies on data. Many investment funds rely on understanding what is occurring — and might occur in the future — within specific companies as well as the larger markets to make the moves that will reap the most reward.
For fund managers and dealmakers, a deal sourcing platform can provide the critical insight necessary to make smarter decisions. With millions of data points available and the tools to make use of them, Sourcescrub can help you be more successful. See for yourself and request a demo today.
