If you are considering investing your money with a Private Equity Fund Manager, it is important to have a basic understanding regarding how they make money off of your investment, in order to determine whether it is worthwhile for you to invest in the Private Equity Fund at all. Of course, it is more important to understand how you can make money off of your investment, but that is only part of the picture. This article will provide insight into both of these matters to provide a basic understanding regarding how these funds work.
When you invest your savings into a Private Equity Fund you are giving these funds to a Private Equity Fund Manager to invest on your behalf. The strategy used by the Private Equity Fund Manager is dependent on the fund that is entered into. Some have bullish strategies that they develop, others purely international, while others promise that their fund can succeed in any old environment (generally called a multi-strategy fund). You should start by having an understanding of these different fund types and which one you believe fits your investment profile of risk/reward.
A Private Equity Fund Manager makes all your financial decisions in regards to your invested capital for you, but has to comply with the fund agreement. Some funds require regular payouts of distributions, while others do not. If the fund’s assets appreciate, you receive a gain on your investment that will either be paid out through distributions or a return of capital when you request a payment. If the fund’s assets depreciate due to poor investments or general economic worries, your investment will be a loss overall and you will lose on your investment.
Although a great variety of different arrangements exist, the typical Private Equity Fund manager will receive an annual payment representing a percentage of the assets that you invest. In many circumstances this will be approximately 1% of the invested capital. This is one way that an investment fund manager will cover their expenses and earn profit on investing your money. The second way is through something called a carry. A carry is a reward for the Private Equity Fund Manager for earning an outsized return. For example, if the Private Equity Fund exceeds a return of 20%, many will begin to split the return above 20% with the investors. Therefore, if there is a return of 30%, the fund manager will receive 5% of the return, in addition to the management fee noted above. As a result of this arrangement, the Private Equity Fund Manager has an incentive to try to earn a higher return for you, but may be compelled to take outsized risks to obtain this return.
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