Private Funds

Private Funds are investment vehicles that pool capital from a select group of investors to deploy in various strategies. Think of them as exclusive investment clubs, a world away from the mutual funds or exchange-traded funds (ETFs) available to the general public. They are “private” because they do not solicit capital from the public and are not registered with regulatory bodies like the U.S. Securities and Exchange Commission (SEC) in the same way public funds are. This lighter regulatory touch gives their managers immense flexibility in what they can buy and how they can invest. Instead of being limited to stocks and bonds, they can venture into complex derivatives, distressed debt, private companies, or real estate—areas often out of reach for ordinary investors. This freedom, however, comes with a trade-off: higher risk, less transparency, and a high barrier to entry, typically reserved for institutions and very wealthy individuals.

Private funds aren't a monolith; they come in many shapes and sizes, each with its own habitat and hunting style.

• Hedge Funds: The chameleons of the investment world. Their goal is often to generate positive returns regardless of whether the market is going up or down (known as absolute returns). They use a vast array of strategies, including short selling, derivatives, and leverage (borrowed money) to amplify their bets.
• Private Equity (PE) Funds: These are the corporate raiders and company builders. PE funds typically buy entire private companies (or take public companies private), with the goal of improving their operations over several years and then selling them for a handsome profit.
  • Buyout Funds: The most common type of PE fund, specializing in acquiring mature companies.
  • Venture Capital (VC) Funds: The talent scouts of the business world. VCs invest in promising but unproven startups and early-stage companies, hoping to find the next Google or Amazon. It's a high-risk, high-reward game.
• Real Estate Funds: Just as it sounds, these funds pool money to invest in property—from office buildings and shopping malls to apartment complexes.
• Infrastructure Funds: These funds take a very long-term view, investing in essential physical assets like toll roads, airports, pipelines, and power plants.

You can't just walk in and join a private fund. Access is restricted to sophisticated investors who are presumed to be able to fend for themselves and absorb potential losses. In the United States, this typically means you must be an:

• Accredited Investor: Generally, an individual with a net worth over $1 million (excluding their primary residence) or an annual income exceeding $200,000 ($300,000 with a spouse).
• Qualified Purchaser: A more exclusive tier, typically requiring at least $5 million in investments.

These funds are typically structured as a limited partnership, where investors (the limited partners, or LPs) entrust their capital to the fund manager (the general partner, or GP). Similar rules on investor sophistication exist in Europe and other regions, ensuring that these less-regulated, higher-risk products are kept out of the hands of retail investors who might not fully understand the dangers.

For a disciple of Benjamin Graham or Warren Buffett, private funds present a fascinating paradox. They embody certain value principles while violating others.

The main appeal is the potential to access opportunities unavailable in the public markets. A private equity manager, in theory, acts like a true business owner—buying a whole company, fixing it up, and selling it years later. This long-term, business-focused approach resonates deeply with value investing philosophy. Instead of betting on fleeting stock price movements, you're betting on fundamental business improvement. It's the ultimate “buy and hold” strategy, but with entire companies instead of small slivers of stock.

Despite the appeal, there are serious drawbacks for a value investor.

• Exorbitant Fees: The typical fee structure is the “2 and 20” model. Managers charge a 2% management fee on all assets each year, regardless of performance, plus a 20% performance fee, known as carried interest, on any profits. Buffett has famously criticized this model, arguing that it creates a “heads, I win; tails, I don't lose much” situation for managers, who get paid handsomely even for mediocre results. These fees create a massive hurdle for returns.
• Illiquidity: When you invest in a private fund, your money is typically locked up for 7-10 years, or even longer. This lack of liquidity is a major risk. You can't just sell your stake on a Tuesday afternoon if you need cash or change your mind.
• Opacity: Private funds offer very little transparency. You get periodic reports from the manager, but you don't have the real-time data and detailed public filings that you get with a publicly-traded company. You have to place enormous trust in the fund manager, which runs counter to the value investor's creed of doing your own thorough research.

In short, while the idea of private funds can be appealing, the reality of high fees and low transparency often makes them a poor choice compared to finding undervalued, well-run businesses in the public stock market.