Is a Private Equity Fund a Pooled Investment Vehicle?

The financial investment landscape can often appear complex, especially with the emergence of specialized vehicles designed for particular investment strategies. This article aims to clarify whether private equity funds fall under the classification of pooled investment vehicles, providing insights into their operational mechanics and unique characteristics.

What are Pooled Investment Vehicles?

A pooled investment vehicle (PIV) is an entity that gathers funds from multiple investors to invest collectively in various securities and assets. This structure enables individual investors to benefit from economies of scale, diversification, and professional management that might be challenging to achieve on their own.

These vehicles are typically managed by investment professionals who decide how to allocate assets to meet the investment vehicle’s objectives. Investors in a PIV are stakeholders in every investment the fund makes, proportional to their contribution. Common examples of PIVs include mutual funds, exchange-traded funds (ETFs), and hedge funds. This pooling allows for lower trading costs per dollar of investment and broad diversification across multiple asset classes or sectors.

Defining Private Equity Funds

A private equity fund is a pool of capital raised to invest in private companies or to take public companies private, with the objective of generating a high rate of return. These funds are typically structured as limited partnerships, where a private equity firm acts as the general partner (GP) and raises capital from various investors who become limited partners (LPs). The primary function of these funds is to acquire equity ownership stakes in companies, often with the goal of improving their value over time before selling them for a profit.

Key characteristics of private equity funds include the illiquid nature of their investments. They also typically have long investment horizons, often ranging from 5 to 10 years or more, reflecting the time needed to grow and exit an investment. Fund managers play an active role in the companies they invest in, often engaging in operational restructuring and strategic management to increase value. Investors in private equity funds are generally institutional investors and high-net-worth individuals, due to high investment minimums.

How Private Equity Funds Function as Pooled Investment Vehicles

Private equity funds are indeed a type of pooled investment vehicle. They explicitly meet the definition by combining capital from numerous investors into a single fund. This collective capital is then managed by a professional private equity firm, which acts as the general partner.

The pooled capital allows the fund to make significant investments in private companies that individual investors would typically not be able to access on their own. The fund, not the individual investors, directly chooses specific portfolio companies and manages those investments. This aggregation of resources provides benefits such as economies of scale and diversification across a portfolio of private companies.

Unique Aspects of Private Equity Funds as PIVs

While private equity funds operate as pooled investment vehicles, they possess distinct characteristics that set them apart from more common PIVs like mutual funds. One significant aspect is their limited access; private equity funds are generally open only to accredited investors or qualified clients. This is due to higher investment minimums and less stringent public disclosure requirements compared to publicly traded funds.

Unlike mutual funds or ETFs that offer daily liquidity, private equity investments are long-term commitments, typically held for several years, making them not easily traded. Furthermore, private equity funds often employ a “2 and 20” fee structure. This typically involves an annual management fee of around 2% of committed capital, and a performance fee, or “carried interest,” of approximately 20% of the profits generated above a certain hurdle rate. This structure incentivizes the fund managers to deliver substantial returns for investors. Finally, private equity fund managers engage in active, hands-on operational involvement with their portfolio companies to drive value creation, which differs from the more passive management styles often seen in other pooled vehicles.