The document provides an overview of investment management including defining investment companies and their key characteristics. It discusses common forms of investment companies such as hedge funds, mutual funds, and private equity funds. It describes private equity fund structures and the roles of general partners and limited partners. It also defines hedge funds and mutual funds and compares the different types of investment companies. Finally, it outlines various capital structures used in investment companies such as stand-alone, master-feeder, and funds of funds structures.
2. Agenda
Investment Companies - Definition
Characteristics of Investment Company
Common forms of Investment Companies – HF/MF/PE
Capital Structure
COE :
SAS-70 team for SAR reviews of SOC 1 reports
ABC team for Audit Opinions
ESC Team for Engagement letters
IT Specialists
3. Investment Companies
An entity must have the following fundamental characteristics to be
an investment company: [FASB ASC 946]
a) b)
It is an entity that does both of the following:
i)Obtains funds from one or more investors and
provides the investor(s) with investment
management services
ii)Commits to its investor(s) that its business purpose
and only substantive activities are investing the
funds for returns from capital appreciation,
investment income, or both
The entity or its affiliates do not obtain or have the
objective of obtaining returns or benefits from an investee
or its affiliates that are not normally attributable to
ownership interests or that are other than capital
appreciation or investment income.
4. Characteristics of an Investment Company
An entity should assess whether it has the following typical characteristics of an
investment company:
a. More than one investor
b. More than one investment
c. Investors that are not related parties of the parent entity (if there is a
parent) or the investment manager
d. Ownership interests in the form of equity or partnership interests
e. Substantially all investments are managed on a fair value basis
5. Forms of Investment Companies
Private Equity Hedge Fund Mutual Fund
Leveraged Buyouts (LBOs): Capital typically consists of an equity investment, and a larger
debt investment Assets of the company are used as collateral for the loans and the
cash flow of the company is used to pay off the debt.
Venture Capital: Involves the provision of capital to business enterprises in the early stages
of the development of new products or services.
Fund-of-Funds: Fund invests in other private equity funds, as opposed to Direct Investments.
Mezzanine Debt / Distressed Debt: Share characteristics of both debt and private equity
financing Providing a middle level of financing.
Secondary Purchases: A small group of the private equity firms specialize in purchasing
secondary interests in private equity partnership interests.
6. Private Equity
Structures are made keeping in mind tax efficiencies
Usually structured as LP or LLC.
There could be a single LP or multiple LP or AIV or Investment vehicle which hold investments in portfolio
companies
Governed by partnership agreement
Defined life – 10 years with two one-year extensions
Seek to generate returns through longer term appreciation from investments in privately held and non-listed
publicly traded companies
Institutional and private individuals typically investing in private/public companies through investment
company entities.
Key Players in a Private Equity Fund
General Partner: Individuals or entities, who manage and advise the fund (i.e., they perform all record
keeping functions and are authorized to enter into transactions on behalf of the investment fund).
Generally, they invest a limited amount (usually 1%) of capital in the investment fund.
Limited Partner: The individuals or entities that invest a significant portion (usually 99%) of the capital in the
investment fund. They do not perform any other services in relation to the investment fund (i.e., they are
not involved in any of the management activities).
8. Hedge Fund - Definition
Private, unregistered investment pools that are not widely available to the public
and have traditionally been limited to accredited investors and large institutions
[Ex. High Net Worth Individuals/Corporations/Fund of Funds/Institutions]
originated as private investment funds that combined long and short equity
positions within a single leveraged investment portfolio.
employ a wide variety of trading strategies and techniques to generate financial
returns.
not subject to certain regulations, such as that apply to mutual funds, for the
protection of its investors.
9. Mutual Funds - Definition
An investment vehicle that is made up of a pool of funds collected from many
investors for the purpose of investing in securities such as stocks, bonds, money market
instruments and similar assets
Operated by money mangers, who invest the fund's capital and attempt to produce
capital gains and income for the fund's investors
A mutual fund's portfolio is structured and maintained to match the investment
objectives stated in its prospectus
10. Private Equity Hedge Funds Mutual Funds
Investors
Institutional
High net worth
Institutional
High net worth
Retail – Individuals
Investments
Long Term
Illiquid/Private
Short Term Trading
More Illiquid
Non-Public
Derivatives
Combination
Liquid
Public/Diversified
Liquidity
Infrequent
Lock ups
Monthly/Quarterly Frequent/Daily
Regulations
Less regulated Less regulated Regulated
Driving
Agreements
LPA [Limited partnership
agreement]
OM [Offering
memorandum]
Prospectus
Key Differences
11. Capital Structures
Stand alone Master-feeder Fund of funds
Simple
investment
structure –
invests in other
securities
Master - Generally organized as a trust or LLC in case offshore
funds that usually qualify as a partnership for tax purposes.
Feeders are generally organized as corporations or trusts, may
be taxed under the IRC as regulated investment companies
Master will usually perform investment management function
where as feeder will usually perform distribution function.
Master will usually have custodian and advisory fee expenses
where as feeder will usually have distribution and shareholder
servicing
Fees & expenses incurred by master & feeder must be in
accordance with the contractual agreement as disclosed in the
registration statement.
Each feeder must be allocated its share of gain or loss realized
by the master on an aggregate basis.
Reasons for master-feeder structure marketing advantage,
allows foreign investors to invest in US and vice-versa, in case of
some offshore funds no requirements to report identity of foreign
investors, etc.
A Fund of funds is an investment
fund that holds a portfolio of other
investment funds rather than
investing directly in shares, bonds
or other securities.