Investments Part 2: Types of investments

So today I will be talking about investment funds

Venture Capital Funds

Hedge Funds

Venture capital is a method of benefitting smaller start-ups by investing money into them. This is so that the business can use the VC’s investment to upscale their business, this allows the VC to make a profit as the business grows.

Venture Capital may possibly the most difficult type of investing to succeed in as the Kauffman Foundation stated that 62% of venture capital funds fail to exceed stock market returns. Let alone the substantial size of investment required, which is anywhere between $1 Million and $5 Million. Meaning that it would be practically impossible for individuals who don’t fall in the Ultra-high-net-worth bracket to invest using this strategy. On the other hand, there are very high returns as The National Bureau of Economic Research has stated that in VC, 25% is the average return per investment. The top quartile of VC funds have an average annual return ranging from 15% to 27% over the past 10 years making them significantly more profitable than the S&P 500 which has had an average growth of 9.9% per annum in the last decade. VC funds trade in illiquid equity as the stake in the start-ups they purchase is not tradable as the small businesses’ stock does not have a proper valuation and thus is worthless until its IPO.

Hedging is a method to reduce risk taken on by investing in a certain equity (usually stocks) in which the investor safeguards a drop of price in the desired equity by investing in a separate equity which would have the inverse reaction to the stimulus which caused the drop in the price of the desired equity. Put simply- the investor puts money into 2 different stocks which will react differently to and if one falls in value, the other increases in value therefore, the risk of the investment is mitigated. This is how Hedge funds got their names however they don’t stick to the minimising risk aspect of hedging, instead they are known for high risk, aggressive investing.

Hedge funds are usually leveraged to chase large returns. Leveraging is where investors/traders use other peoples’ money to trade with. They purchase securities on margin, meaning that they leverage a broker’s money to make larger investments. They invest using credit lines and hope that their returns outpace their interest. Leveraging allows hedge funds to significantly increase their potential profits but also do the same to their potential losses. Thus, if the bets go against them, they will suffer an increased risk of failure if the bets go against them therefore the business can go bankrupt if the market experiences a sudden change. Hedge funds also trade in derivatives (financial contracts between 2 or more parties that derive their value from an underlying asset, group of assets, or benchmark. Hedge funds bring in billions of dollars per year because of their complex trading system which allows them to make large profits.  Hedge funds also almost exclusively trade in liquid assets while the funds themselves being illiquid, they require someone who has invested in the hedge fund to keep their money invested for an entire year before they are able to close their investment in the fund