The area of alternative investments is gaining momentum among many investors, and as consequence, numerous options are available, and a greater variety of funds is currently offered, along with multiple ways of investing in them. Listed below are several types of investment funds in the alternative capital market:
A private equity fund is normally established for the purpose of purchasing companies or assets with improvement potential, or distressed companies or assets, with the intention of enhancing their profitability and then realizing the investment. Behind the name private equity hide different types of equity funds, distinguished by the size of the companies in which they invest, the stage of the lifespan of the companies they enter, the types of assets and the nature of the investment.
The entity establishing the fund is the General Partner (GP) that recruits investors who become Limited Partners (LP), and therefore the legal structure of the fund is generally that of a limited partnership, limited by a particular lifespan.
The fund identifies investments based on a predefined policy and realizes the investments within a limited time, in most cases about 10 years, at the end of which the fund is to be wound up. Private equity funds tend to invest in companies that have strong potential of exit or IPO, with the aim of taking control of a company that has reached maturity and already generates revenue from its product or service. The objective of the fund is to generate value through growth and/or streamlining, while relying on the fund manager’s experience. This means that the relationship between the venture and the private equity fund will generally occur from round C, when the venture is in advanced stages – i.e. the Late Stage and the Maturity Stage.
Is a private investment fund, which invests in start-up companies, mostly in the field of technology but not only, in various investment stages: “Pre-Seed” and “Seed” (initial stages of establishment and operation), investment in early stages of active companies, investing in mature and stable companies and so on. Investment in these companies has the potential for a high return if the company is successful. However there is also a risk in these companies, as some of the companies will not reach their destination and will fall flat during the development process and the fund’s investments in these companies may be wiped out. Thus, the investment strategy of venture capital funds, which invest in only a few percent of the ventures presented to them, is based on an examination of the likelihood of an exit within a few years from the date of investment, alongside the future value and expected return on that exit.
A hedge fund is a private equity fund purporting to generate profits for investors under all circumstances and regardless of the market condition. A hedge fund is so named because in its essence, every transaction is hedged with a clear investment goal. Hedge funds employ various strategies to earn an active return, or alpha, for their investors. Hedge funds may be aggressively managed or use derivatives, and they operate in both local and foreign markets.
The legal structure of a hedge fund consists of two different legal entities. The first entity is the General Partner, whose role is to manage the fund and earn management fees. The general partner does not bear any risk from the fund, nor does it share the fund’s profits or losses. The second entity is the “fund” itself, which incorporates all members. These members equally share profits and losses. A fund is considered by law to be a hedge fund as long as it is an arrangement between no more than 50 individuals and no offer is made to the public. One aspect that distinguishes the hedge fund industry from the mutual fund industry is the fact that hedge funds cope with less regulation, which allows them to make more sophisticated investments and respond faster to the market.
Listed below are the key strategies of hedge funds:
Long/Short Equity – An equity hedge fund which, on one hand, is exposed to equities, and on the other hand, selling short other equities.
Multi-Strategy Hedge Fund – A hedge fund that invests in all assets and strategies to create large distribution of tradable assets.
Absolute Return – A fund that invests in tradable assets while achieving a positive return in any given point in time.
Fund of Funds – A fund that invests in other hedge funds and generates an average return from these funds by dispersing the investment therein. The advantage of such funds is that they are also open to investments in small amounts.
Infrastructure funds can invest in projects such as water desalination, sewage treatment and waste recycling; Roads, mass transit, seaports, airports and car parks; Electrical facilities, refining facilities, transmission infrastructure, fuel and gas products and storage facilities; telephony, Internet, cable, satellite and broadcast distribution infrastructure; Or any infrastructure executed in a cooperation agreement between the state and the private sector (PPP tenders).
Funds can invest in projects that are in the initiation and construction stages, where the risk on the fund is higher, so return is higher respectively. Still, most of the funds invest in existing projects that are characterized by assets with a stable and protected cash flow in the operating stages, which include an upside component that involves active management by the funds.
Recently, the State of Israel has been encouraging the listing of infrastructure funds at the stock exchange, so for the first time the public will be able to invest in infrastructure projects. Infrastructure funds will benefit from tax relief, taxation of profits will be directly in the hands of the shareholders, as is customary in RIT funds without any taxation on the fund itself. In addition, in order to encourage investment by provident funds and institutional entities that manage long-term instruments (pension savings), these entities will be exempt from tax on all fund income, except for exceptional income (unrelated to the fund’s core business).
Infrastructure projects are often characterized by high operational and engineering complexity and therefore their main source of credit is in the banking system, large institutional entities and funds operating in the field. The cooperation between the public sector and the private sector in the development and construction of infrastructure projects through the Public Private Partnership (PPP) is a world-renowned method that permeated Israel in the early 1990s when the first flagship project was Highway 6.
PPP projects are characterized by: long-term agreements, the possibility to take advantage of the relative edge of each sector and the ability to split the various risks among them in the most efficient way. For example, while the public sector is usually responsible for the land and the risks of force majeure, the private sector is responsible for financing, establishing and operating the projects in practice and over time. In this way, the government can initiate huge projects, even if it cannot budget their full cost and spread the cost over a long period of operation. The private entrepreneur recovers his investment in the project, as part of the license or operating franchise he won.
Real estate funds are funds that invest in different types of real estate properties where the return target depends on the risk level. In this regard, income-generating real estate funds should be distinguished from development property funds.
Funds investing in income-generating real estate, such as office and apartment buildings in popular areas, logistics centers, student housing, hotels, assisted living centers, etc., allow investors to benefit from the know-how of industry professionals, with a small amount of money compared to direct real estate investments. Moreover, these funds enable distributing the investment over many real estate properties, in proportion to the high risk involved in investing in one property. Many transactions in the field of commercial offices and centers focus on properties with relatively low occupancy rates, which are expected to increase and, as consequence, the current income from such property is also expected to increase. Most transactions in the residential field involve the acquisition of income-generating properties that are not well managed but have the potential to improve following renovation, while increasing the rent.
A Development Real Estate Fund consists of a group of investors cooperating in the acquisition of real estate properties that have not yet been built. Each investor owns interests in real estate properties in proportion to his share of the investment. The capital raised by the real estate fund from its members completes the equity required by the developer to obtain bank financing for the construction.
The area of debt is characterized by a large number of investment funds using different investment strategies. In most cases, each fund has expertise in a particular area of debt that it tries to perfect to create excess return, reduce the number of insolvencies and exhaust the collateral for the debt to the maximum extent possible. Debt funds mostly invest in non-negotiable debt assets, thereby allowing the investor to be exposed to a broad variety of debt alternatives to which he cannot be exposed through negotiable debt markets. Over the past few years, financing by non-bank credit institutions has increased, as commercial banks have reduced their real estate financing activities, mainly due to the increasing demand for capital. Generally, the due diligence and underwriting process as well as the process of providing the loans are done in a banking format and similar to the regular process, but in smaller amounts and at a speed that allows developers to execute attractive investments. One of the examples of debt funds using a particular strategy is a P2P investment fund. A large number of online platforms exists around the world, which enable to take or give different types of loans (debt) through online automated brokerage platforms that are highly efficient in the operational aspect of extending credit (compared with the banking system) as well as the development of automated underwriting, which replaces human underwriting. Debt investment funds provide their clients with the advantage of a spread portfolio, and are distinguished by the number of loans, the different types of platforms and borrowers (in terms of geography, profession, the purpose of taking the loan, etc.). Furthermore, the fund automatically refinances the investment and eliminates the investor’s need to engage the matter.
There are also investment funds that specialize in real estate debt. In recent years, the commercial real estate activity that is financed by non-bank credit institutions has increased. Real estate is the product with the largest asset value in the world, as its size and relatively narrow stability range have created the largest debt market. Another significant characteristic of the real estate debt market is the ability to mortgage property against the loan. The cost of the loan depends on the amount of the lien and the nature of the property. The two funds differ in the form of the lien and the type of debt (senior, subordinate or mezzanine). The needs of the borrowers are more diversified and include, among others, all-purpose loans secured by real estate, bridge loans and loans designed to supplement equity capital.
This segment consists of acquisitions of units in investment funds from investors seeking GP-led liquidity solutions, mostly with a significant discount compared to the value of the purchased property. Secondary Funds provide liquidity to the private equity and venture capital markets, through the acquisition of holdings in funds as well as direct holdings in private companies at the end of their life, including, inter alia, companies that have failed to reach an exit. The types of transactions in Secondary Funds include acquisitions of LP (i.e. Limited Partners) positions in private equity and venture capital funds (Secondaries), acquisitions of minority holdings (Secondary Direct) and structured deals, such as addition of capital to existing private equity and venture capital funds.
In conclusion, a diverse range of alternative investment funds are available in the market, and each entity is advised to make its own transactions based on the level of risk, current portfolio investments and the diversity of the portfolio, the need for liquidity and more.
Objective will be happy to provide objective advice on capital-raising funds.