Private equity fund (PEF) - what is it? How is it arranged? Types of funds

Investments in startups are associated with risks, since according to statistics, at best, one project out of ten turns out to be profitable. Diversification helps you make a profit. But a private investor, even with large capital, can hardly diversify adequately, and it is not a fact that his investments will be successful. Therefore, it is easier to invest in a direct investment fund - the shareholders’ capital will be managed by professional traders, who have an order of magnitude higher chances of successful investments.
From this article you will learn:

1. What is a private equity fund?
2. How does a private equity fund work?
3. Types of private equity funds
4. Where does PEF invest?
5. Who can invest?
6. Private equity funds in Russia

What is a private equity fund?

A private equity fund , as well as a PEF (Private Equity Fund) is something between traditional mutual funds and venture funds. According to the Russian classification, it is classified as a closed-end mutual investment fund, since it involves collective investment in securities, and shares can only be purchased by qualified investors.

Unlike classic mutual funds, PEF invests in shares of companies that have not yet entered an IPO, i.e. makes investments in the over-the-counter market. In addition to shares, a private equity mutual fund can invest in:

• in bonds of non-public companies;
• in bills, receipts and other promissory notes of companies;
• shares and shares of other funds investing in startups.

The specific structure of assets is described in the investment declaration - a document that determines the investment strategy of the fund.

PEF's investment principles are similar to venture funds. While classic mutual funds invest in stocks and bonds traded on the secondary market (i.e., stock exchange), private equity funds invest directly in companies (hence the name).

There are different forms of investment:

• direct participation in capital (purchase of a share);
• purchase of debt securities;
• share repurchase.

The main goal of investing in private equity funds is to take the company to a higher level (for example, to an IPO) with the further sale of shares or debt. Of course, entering the stock exchange is a rather ambitious goal, and the fund simply brings most projects to payback and receive a stable profit, and then resells them.

Investments in private equity funds imply a fairly long period of participation - on average from 5 to 7 years.

How to choose an investment fund: 5 criteria

Decide on a goal

If your goal is active capital growth, consider equity funds. Historically, ETFs and mutual funds that track indices of small and mid-cap companies provide greater profits. But remember that in conditions of increased volatility and crises, the market cannot always grow. The higher the expected return, the higher the risks.

To form a “safety cushion”, conservative investment funds – bond or real estate funds – are more suitable. The average yield is 8-10% in foreign currency.

• If the market is very overheated, sooner or later this will affect your capital. Therefore, it is optimal to add both stock funds and bond funds to your portfolio. This will help diversify your investments.
• The 40/60 strategy is considered medium risk, where 40% of the portfolio is allocated to equity funds. The remainder goes to bond investment funds.
• It is also optimal to distribute investments between ETFs of different countries/sectors/industries. The assets of different ETFs should be independent from each other, so that there is no strong positive correlation.
• Another interesting option is “all-weather funds”, consisting of 30% stocks, 15% bonds and commodities, 55% bonds with different maturities. Such ETFs are more suitable for conservative investors, as they provide returns slightly below the market average.

About

How does a private equity fund work?

Technically, in terms of organization, a private equity investment fund is an ordinary LLC created for a certain period (while the investments will work). Its structure includes:

• managing partner – an individual or legal entity who is directly involved in investing funds;
• limited partners are investors who participate in the capital of the fund.

Not only individuals, but also other venture and hedge funds, banks, management companies, insurance companies, non-state pension funds, etc. can act as investors. They purchase shares, the value of which is calculated using a simple formula:

• unit price = fund assets / number of units.

Obviously, the higher the value of the fund's assets, the more expensive the share is.

In most cases, private equity funds are closed, i.e. their shares are not traded on the exchange market and are not available for direct sale, like shares of open-end funds. Redemption of units is made only after the dissolution of the fund, and not at any time.

A private equity fund operates like a typical management company. The managing partner looks for promising startups, chooses a form of cooperation and invests money in the companies.

In accordance with the law, the share of one investor in PEF cannot exceed 10% of the total value of assets, and more than 10% of the capital cannot be invested in one project.

Some funds do not work directly with startups, but through portfolio companies - i.e. other venture funds. The fact is that the threshold for entry into venture investments is quite high for an individual investor, but in the course of collective investment it is easier to collect the required amount.

What types of funds are there: understanding ETFs and mutual funds

The most popular types of investment funds are ETFs and mutual funds. They work according to the same “pattern”: they follow a certain underlying asset - a stock index.

A stock index is an abstract set of financial assets grouped according to a specific characteristic. The selection criterion can be anything. For example, belonging to a certain industry, sector or country, high dividends.

What are indexes for? Let's go back to our fruit example.

• Let’s say an apple costs 30 rubles, an orange – 40 rubles, a cherry – 50 rubles. Together this “basket” costs 120 rubles.
• Knowing the cost of the set, we can track how the cost of all 3 fruits will change as a whole, and not individually.

Stock indices work in a similar way:

• There are tens of thousands of companies in the world. It is quite difficult to track the prices of each individual security.
• Therefore, securities are grouped by indexes. This way it is much more convenient to view the general trend, since the index reflects the movement of prices for a “basket” of assets.

Indices are the underlying asset of the fund most often. For example, the underlying asset of the FXUS fund is the Solactive GBS United States Large & Mid Cap Index NTR, which tracks the performance of the 500 largest US companies.

There are also closed-end, state investment funds, and collective investment funds. For “ordinary” investors, these are rather “niche” stories.

What is ETF

ETF (or exchange traded fund) are investment funds whose shares are traded on an exchange. #FXUS, #FXRL, #FXGD are classic examples of ETFs.

• ETFs are managed by providers - management companies. iShares, Vanguard, FinEx, BlackRock are the largest of them.
• What do investment companies do? They serve ETFs and invest investors' money in order to increase capital.
• The services of the management company are not free. Therefore, without exception, all ETFs charge a commission - in the range of 0.2-1.5% per year. It all depends on the provider. There is no need to pay commissions separately - they are deducted daily from the cost of the share in the investment fund.

About

Types of private equity funds

In the world, PEF is usually divided into three categories:

• Buyout funds . They specialize in direct participation in the capital of a company, buying out shares or a controlling stake, and subsequently resell their stake. In the United States, such funds make up about 50% of the total venture capital market; in Russia, about 5% of all transactions are carried out this way.
• Growth capital funds . They invest in young companies at various stages of development, mainly through loans or debt buyouts. Bringing companies to wider markets. Control of the company remains with the original owners. There are an absolute majority of such funds in Russia.
• Venture funds . They invest in startups that are at the very early stages of development.

Also, private equity funds can be divided into private and public, domestic and foreign. Most funds in the Russian Federation are private and created with the participation of foreign capital. The only government fund is the Russian Direct Investment Fund (RDIF).

Mutual Fund and Closed Mutual Fund - what is the difference?

Let's understand what mutual funds are and how they work.

What is mutual fund

A mutual investment fund (UIF) is a separate property complex consisting of property transferred into trust management of a management company by the founder (founders) of trust management with the condition of combining this property with the property of other founders of trust management, and of the property received in the process of such management, a share ownership of which is certified by a security issued by the management company.

A mutual fund is not a legal entity.

(Article 10, paragraph 1. Federal Law of November 29, 2001 N 156-FZ (as amended on July 2, 2021) “On Investment Funds” (as amended and supplemented, entered into force from October 1, 2021).

In simple words

A mutual fund is a form of trust management in which each shareholder receives a share of his profit depending on the amount of funds he contributed to the fund.

A mutual fund participant receives an investment share - a registered security certifying its owner’s share in the ownership of part of the fund’s property.

The fund is managed by a professional participant in the securities market - a management company (MC). It has a license to conduct financial transactions and manages the mutual fund in the interests of investors.

The management company invests shareholders' money, for example, in bonds or shares, real estate, currency, in order to generate income from these investments. As the value of the securities included in a mutual fund increases, the cost of one investment unit increases, and therefore the potential income of shareholders. For professional capital management, the management company charges a fee - a remuneration for its services.

What types of mutual funds are there?

Open - when operations with shares, for example, their issuance and redemption in a management company, can be carried out on any working day.

Interval - only a certain period of time is available for transactions with shares. For example, four times a year for two weeks. Compensation for inconvenience is a higher profitability, since the management company can plan investments without worrying about the fact that shareholders will suddenly withdraw funds.

Closed - you can buy shares of such a fund only at the time of its formation. Most often, a fund is created for a specific project. The terms of operation of the mutual fund are agreed upon in advance. At the end of the time, the investment units are redeemed, investors receive funds from the sale of investment units and disperse. Before the end of the contract, you cannot withdraw your share, unless otherwise provided by the fund's policy.

More about closed mutual fund

Closed-end mutual fund is focused on attracting investments for a certain, usually long-term, period. Its validity period is fixed in the Fund Rules and ranges from 3 to 15 years with the possibility of early termination or extension.

Funds (except for cash), securities (stocks, bonds), derivative financial instruments (futures, options), as well as other property provided for by the fund’s investment declaration and current legislation can be transferred to trust management.

Categories of closed mutual funds

The formation of a closed-end mutual investment fund takes place under a specific investment strategy (and therefore, under a specific investment declaration). Depending on the type of closed-end mutual fund, shareholders' funds are invested in stocks, bills, bonds, real estate, and mortgages.

Types of funds can be globally divided into two large groups:

1. Funds for qualified investors can be divided into three categories:

- fund of financial instruments,

- real estate fund,

- combined fund.

2. Funds for the general public - where no qualifications are required - can be divided into two categories:

— fund of market financial instruments,

- real estate fund.

Each fund category considers investing in strictly defined assets, and the fund's investment declaration is prepared depending on its category.

How does a closed mutual fund work?

A feature of a closed-end fund is that the list of owners and the number of issued shares is determined when the fund is formed, and then for all important events in the fund (additional issue, change in investment declaration), a general meeting of shareholders must be held, at which all decisions on the fund are determined by voting, in which owners of at least 10% of the total number of shares can participate.

The process of raising funds for a mutual fund is called fund formation. The fund begins to operate when the asset value fixed in the Fund Rules is reached, that is, when an amount of funds sufficient to finance the project or object for which the fund is being formed has been collected. The purchase by clients of investment shares of a closed-end fund at the time of their issue (at the time of formation of the fund) is called the initial circulation.

As a rule, after the formation of a closed mutual fund, it “closes” to issue new shares and accept new shareholders. The rules of a closed-end fund may provide for additional issue of investment units after the completion of the formation of the fund, while the owners of investment units have a preemptive right to purchase additionally issued units.

New investors can join the project only with the consent of the closed fund participants, also by issuing additional shares. Upon expiration, the fund is dissolved and the units are redeemed at the current value of the assets.

Secondary circulation (purchase/sale of previously issued shares) of a closed-end mutual investment fund is possible if this is provided for in the rules of trust management of the fund. The client has the right to sell, donate, or bequeath his shares to another person.

An additional feature of a Closed-End Mutual Fund is the possibility of receiving periodic payments if the Fund's Rules provide for the payment of investment income rather than its reinvestment in the Fund's assets. This is a fairly common practice for closed-end real estate funds, where the income received is not always possible to invest in the target financing object: rental payments from the rental of commercial real estate cannot always be used to buy another property. Therefore, fund investors receive payments during the life of the fund, subject to such income.

A closed mutual fund may also have an investment committee (IC) for qualified investors. The IC can approve transactions at the expense of the property of the closed mutual fund and the actions of the management company as a shareholder/participant of the JSC/LLC, whose shares or shares are included in the property of the fund. The investment committee includes shareholders or their representatives, but the management company itself, its employees and representatives cannot be members of the investment committee. The competence of the IC is described in the rules of trust management of the fund.

What do you need to know when working with closed-end mutual funds?

Taxation of the fund

Income tax. Income received by the fund is not subject to income tax.

Taxation of closed-end fund investors

Income tax / personal income tax

The shareholder’s income arises in three cases:

— upon redemption of fund shares, for example upon its termination,

— when selling units on the secondary market, for example when selling them,

— upon receipt of interim income on shares (if such payments are provided for by the rules of the fund).

Transactions with shares and their ownership are not subject to VAT and property taxes.

Thus, the most effective use of a closed-end mutual fund is to reinvest the profits received by the fund into new assets.

Advantages of owning shares of a closed mutual fund:

• Balancing all profits and losses within the closed-end mutual fund, which allows you to optimize taxation throughout the period of ownership of the fund.

• No double taxation. Closed-end mutual fund of financial instruments does not pay taxes on asset gains; the fund investor pays tax only when the share is redeemed and income is received.

• The ability to use a closed mutual fund as a trust and distribute shares between relatives, business partners, etc.

• If the activity of the management company is terminated (deprivation of a license, bankruptcy, etc.), the right of shared ownership of the property of the closed mutual fund remains with the shareholders, the claims of creditors to the management company do not apply to the property of the closed mutual fund.

• The ability to create a fund for the purposes of one or a group of investors: for example, one of the clients has a need to finance a specific project: film production, construction of an apartment building, etc.

• Confidentiality: information about shareholders is not disclosed and is available to a limited number of people.

• Deferment of payment of income tax within a closed-end mutual fund on transactions with fund assets (in the absence of payments of interim investment income).

Investment risks

Risks are associated with the investment strategy of the closed mutual fund, reflected in the rules of trust management of the fund, and the work of the management company.

BCS World of Investments

Where does PEF invest?

The selection of investment objects is carried out according to various principles, including assessment methods and on the basis of insider information. Some funds are created to invest in a specific, predetermined pool of projects. The most common strategies:

• purchasing collateral assets at a reduced price;
• acquisition of a business on the verge of bankruptcy with a return to profitability;
• investing in startups before a sharp breakthrough;
• purchasing companies that are undervalued by multiples;
• merger of several businesses into one;
• entry into a niche market that is uninteresting to large investors.

For his work, the managing partner receives a remuneration, which usually consists of two parts: fixed, which is paid in any case, and variable, the size of which depends on the performance of the work. If the fund is operating at a loss, then the manager will receive money only from the “fix”.

Who can invest?

In Russia, the activities of closed-end mutual funds for direct investment are regulated by Federal Law No. 156-FZ “On Investment Funds” , namely the section “Mutual Funds for Qualified Investors”.

As with all closed mutual funds, only qualified investors can invest in PEFs registered in the Russian Federation . Ordinary individuals and novice investors are virtually prohibited from entering this market, and it is not easy. Without proper preparation and experience, it is very difficult to assess the prospects of a particular fund, and you can make mistakes.

In addition, the threshold for entry into direct investment funds usually starts from several hundred thousand, or even millions of rubles - such an amount, of course, is not available to most Russians.

In the West, private equity funds are considered equal to venture funds. Investments in them can be made in the same way as in Russia, only by qualified investors.

How to buy and sell an investment fund: step-by-step instructions

You can buy investment funds through any Russian broker: on the St. Petersburg (SPB) and Moscow Exchange (MOEX).

• Almost all ETFs and mutual funds on MOEX - index ones (providers FinEx, ITI Capital, etc.) - are available without the status of a qualified investor.

The largest investment funds on the Moscow Exchange

• There are more than 90 funds on the St. Petersburg Stock Exchange. Some of them - foreign ETFs - are traded on the over-the-counter market (quala status is required, confirmed through a broker).

The procedure looks like this:

1. We open a brokerage account/IIS with any broker in the Russian Federation with a license from the Central Bank: in the office or online (a passport is enough).
2. We top up the account from a card or any other proposed method.
3. We look for the desired ETF in the search - by ticker. For example, the ticker of the FinEx USA UCITS ETF (invests in the largest US companies) is #FXUS.
4. Go to ETF/bPIF: click the “Buy” button. We indicate the number of lots (shares), the price (not lower than the market price) and confirm the opening of the position.

To sell shares or fund units, we follow a similar procedure:

1. We go to the trading terminal or the broker’s mobile application.
2. Select the desired asset and click the “Sell” button.
3. We indicate the required number of lots and the price (for a quick transaction - market (current).

Let's sum it up

Investment funds are a proven way to diversify a portfolio. A wide selection of options on MOEX and St. Petersburg Exchange allows you to choose the optimal ETF/bPIF in terms of risk and profitability.

Checking the fund is a must before purchasing. Carefully study the information about the management company, the underlying asset and profitability. You should not invest exclusively in one investment fund. Remember to diversify: don't put all your eggs in one basket.

Private equity funds in Russia

There are not many private equity funds in Russia compared to more economically developed countries. In addition, their activities are more regulated when compared with the laws of the USA and Europe. Opening and managing venture and hedge funds abroad is much easier than in the Russian Federation. Therefore, many funds operating in Russia actually have foreign “registration” and foreign investors as the main ones.

The largest Russian private equity funds:

• Baring Vostok Capital Partners is one of the oldest private equity funds with more than $3.7 billion under management;
• United Capital Partners;
• Alfa Capital Partners;
• Russia Partners;
• Delta Private Equity Partners;
• Mint Capital;
• Troika Capital Partners;
• Runa Capital.

This industry is still in its development stage. Every year, a large number of private funds appear, many of which are created to finance one key or a number of small, but united on one basis, projects. For example, private venture funds are created at enterprises to develop new production in order to take advantage of tax benefits.

In 2011, the state-owned Russian Direct Investment Fund (RDIF) was created , which plays a key role in attracting direct investment into the economy of our country. It manages more than $10 billion. Among the projects implemented by the fund are the Child and Mother Group of Companies, Geropharm, the Karo cinema chain, the construction of the Central Ring Road 3 and 4, a railway bridge between the Russian Federation and China, small hydroelectric power stations in Karelia, and the construction of the Sibur plant. The fund also implements joint projects with Magnit, Polyus, Alrosa, Gazprom Neft, Lenta, and participates in the development of the Moscow Exchange and the Metal Exchange.