ADDX Academy: Private Funds?

Key Takeaways

Private funds are funds that exist outside the public securities markets
Examples include hedge funds, venture capital and other private equity funds, and private real estate funds
Private funds can expand an investor’s options by offering them exposure to assets and investment techniques not available to the managers of traditional public funds
Private funds can offer the potential for higher returns and/or more attractive dividends than public funds
Risks can also be higher, so investors need to do their homework

What are private funds?

From hedge funds to high-performance venture capital funds, private funds give investors access to a diversified, professionally managed portfolio of private investments. Unlike mutual funds or ETFs, private funds exist outside the public markets.

Private funds can expand an investor’s options by offering exposure to private assets like venture capital and private equity; enable non-traditional ways of investing in public assets, such as the use of leverage; and/or give investors exposure to riskier assets that offer greater return potential. Examples of private funds include venture capital and other sorts of private equity funds, private real estate funds, and hedge funds.

Private funds, which are officially investment companies, must meet specific regulatory criteria to operate because, once they are up and running, they have more freedom to decide where and how to invest than mutual funds do.

For instance, the manager of a hedge fund can engage in investment activities that mutual fund managers are not allowed to use, such as short-selling (using derivatives to profit from falling share prices) and leverage (borrowing to get greater exposure to investment opportunities).

Who can invest in private funds?

In Singapore, the entry-level investment into private funds can run into millions of dollars, making them inaccessible to all but institutional investors and the very wealthy. ADDX, however, democratizes private fund investing by making it available to investors for as little as S$10,000 to invest in primary offerings and as little as S$100 to trade.

To qualify as an ADDX investor, investors need to meet one or more of the following conditions:

•Yearly income of at least S$300,000 or

•Net financial assets of at least S$1,000,000 or

•Net total assets of at least S$2,000,000

What are the advantages of investing in private funds?

Higher Returns – Private funds can offer the potential for better returns than those available in the public markets. Fewer investors may be going after the investment opportunities, and it takes specific skills, time, and deep analysis to identify the ones that offer the most significant growth potential. The trade-off for these potentially higher returns, however, is that the risks can also be higher.

Diversification – As with public funds, private funds spread typically investor’s pooled money across multiple securities in order to ensure one bad investment doesn't spoil the entire basket. Compare this with direct private equity investing where, if the company goes bankrupt, investors may lose much or all their capital.

Fund Manager Expertise – Via the fund’s manager, you can get access to specialist investment experience and knowledge needed to identify investment opportunities in alternative asset classes. These can include private equity, venture capital, private real estate, and hedge funds. Each asset class requires deep knowledge of the drivers of returns and potential risks in securities that are not publicly traded.

What are the disadvantages?

Higher Risks – While investors get exposure to assets that can potentially produce larger returns and capital growth, the risks of something going wrong in the underlying investments can also be higher. For example, venture capital funds invest in companies that are not yet well-established, and thus the risks of them not meeting investment expectations or even failing outright (and taking all invested funds with them) are higher.

Lack of Liquidity – Once investors have committed their capital, they are usually tied into the investment for the fund's lifespan, which, in the case of private equity and venture capital funds, can be anything from seven to ten years, if not longer. However, this is changing. ADDX, for example, features a built-in secondary platform, so users have a chance to buy in and cash out of any given investment on their timeline.

High Fees – Fees for private capital funds are typically higher than those charged for public funds. ADDX, however, brings these costs down by leveraging blockchain and smart contract technology.

What types of private funds are there?

Private Equity Funds – These private funds give investors access to companies that are not listed on any stock exchange and require funding for various reasons.

Venture Capital Funds – A subtype of private equity where the fund manager specifically targets smaller, earlier stage start-up companies that they feel have significant growth potential.

Hedge Funds - Let you invest in professionally managed private funds that use sophisticated techniques to pursue high returns.

Private Real Estate Funds - Private real estate funds that invest in retail, commercial and industrial properties. They can offer better dividends than publicly-listed public REITs.

The bottom line

Unlike mutual funds or ETFs, private funds exist outside the public markets. Examples of private funds include private equity funds, venture capital funds, private real estate funds, and hedge funds. Investing in private funds can give investors diversified access to assets and investment management techniques not available in the public market. ADDX allows investors to buy into private funds for as little as S$10,000 (to participate in primary offerings) or even S$100 (to trade).