Types of Company Structure

Contents-
1. Family Offices
2. Holding Company
3. Private Equity
4. Understanding Private Equity- PE
5. Hedge Fund
6. Hedge Fund vs Private Equity Fund: What’s the Difference ?
7. Asset Managment Company (AMC)

1. Family Offices

What Are Family Offices?

Family offices are private wealth management advisory firms that serve
ultra-high-net-worth (UHNW) investors. They are different from
traditional wealth management shops in that they offer a total
outsourced solution to managing the financial and investment side of an
affluent individual or family. For example, many family offices offer
budgeting, insurance, charitable giving, family-owned businesses, wealth
transfer, and tax services.

Understanding Family Offices

Some high new-worth individuals may want to consider opening a family
office. A family office provides a wider range of services tailored to meet
the needs of HNWIs. From investment management to charitable giving
advice, family offices offer a total financial solution to high net worth
individuals. In addition, the family office can also handle non-financial
issues such as private schooling, travel arrangements, and miscellaneous
other household arrangements.

Family offices are typically either defined as single family offices or multi-
family offices – sometimes referred to as MFOs. Single family offices serve
just one ultra-affluent family while multi-family offices are more closely
related to traditional private wealth management practices, seeking to
build their business upon serving many clients. Multifamily offices are
more prevalent due to economies of scale that allow for cost sharing
among the clientele.

KEY TAKEAWAYS
 Family offices are full-service private wealth management services
that serve just one or a small number of ultra-high-net-worth
families.
 Beyond basic financial services, family offices also provide concierge
services, planning, charitable giving advice, and other
comprehensive services.
 Single family offices serve just one individual and their family, while
multi-family offices serve a small few and may benefit from
economies of scale.

The Many Disciplines of a 'Family Office'

Providing the advice and services for ultra-wealthy families under a
comprehensive wealth management plan is far beyond the capacity of
any one professional advisor. It requires a well-coordinated, collaborative
effort by a team of professionals from the legal, insurance, investment,
estate, business and tax disciplines to provide the scale of planning,
advice and resources needed. Most family offices combine asset
management, cash management, risk management, financial planning,
lifestyle management and other services to provide each family with the
essential elements for addressing the pivotal issues it faces as it navigates
the complex world of wealth management.

Legacy Planning and Management

After a lifetime of accumulating wealth, high-net-worth families are
confronted with several obstacles when trying to maximize their legacy,
including confiscatory estate taxes, complex estate laws, and complicated
family or business issues. A comprehensive wealth transfer plan must
take into account all facets of the family’s wealth including the transfer or
management of business interests, the disposition of the estate,
management of family trusts, philanthropic desires and continuity of
family governance. Family education is an important aspect of a family
office; this includes educating family members on financial matters and
instilling the family values to minimize intergenerational conflicts. Family
offices work collaboratively with a team of advisors from each of the
necessary disciplines to ensure the family’s wealth transfer plan is well-
coordinated and optimized for its legacy desires.

Lifestyle Management
Many family offices furthermore act as a personal concierge for families,
handling their personal affairs and catering to their lifestyle needs. This
could include conducting background checks on personal and business
staff; providing personal security for home and travel; aircraft and yacht
management; travel planning and fulfillment; and streamlining business
affairs.

2. Holding Company
What Is a Holding Company?
A holding company is a parent corporation, limited liability company, or
limited partnership that owns enough voting stock in another company,
that it can control that company's policies and oversee its management
decisions.

Although a holding company owns the assets of other companies, it

merely maintains oversight capacities and therefore does not actively
participate in running a business's day-to-day operations.

Understanding Holding Companies

A holding company exists for the sole purpose of controlling other
companies, whether they be other corporations, limited partnerships or
limited liability companies. Holding companies may also own property,
such as real estate, patents, trademarks, stocks, and other assets.

Businesses that are 100% owned by a holding company are referred to as

"wholly owned subsidiaries." Although a holding company can hire and
fire managers of companies it owns, those managers are ultimately
responsible for their own operations. It is thus crucial for owners to keep
a sharp eye on its businesses to make sure they are running optimally.

KEY TAKEAWAYS
 A holding company is a parent corporation, limited liability
company, or limited partnership that owns enough voting stock in
another company so that it can control that company's policies and
oversee its management decisions.
 Although a holding company owns the assets of other companies, it
merely maintains oversight capacities and therefore does not
actively participate in running a business's day-to-day operations.
 Holding companies enjoy the benefit of protection from losses,
where if a subsidiary company goes bankrupt, its creditors cannot
legally pursue the holding company for remuneration.

The Benefits of Holding Companies

Holding companies enjoy the benefit of protection from losses. If a
subsidiary company goes bankrupt, the holding company may experience
a capital loss and a decline in net worth. However, the bankrupt
company’s creditors cannot legally pursue the holding company for
remuneration.

Consequently, as an asset protection strategy, a parent corporation might

structure itself as a holding company, while creating subsidiaries for each
of its business lines. For example, one subsidiary may own the parent
corporation's brand name and trademarks, while another may own its
real estate, another may own the equipment, and still others may own
and operate each individual franchise.

This tactic serves to limit the financial and legal liability exposure of the
holding company and of the various subsidiaries. It may also depress a
corporation's overall tax liability by strategically basing certain parts of its
business in jurisdictions that have lower tax rates.
Other Advantages of Holding Companies
Holding companies also let individuals protect their personal assets,
because those assets are technically held by the corporation, and not by
the person, who is consequently shielded from debt liabilities, lawsuits,
and other risks.

Holding companies support their subsidiaries by using their resources to

lower the cost of much-needed operating capital. Using a downstream
guarantee, the parent company makes a pledge on a loan on behalf of
the subsidiary, helping companies obtain lower interest rate debt
financing than they otherwise would be able to source on their own. Once
backed by the financial strength of the holding company, the subsidiary
company's risk of defaulting on its debt drops considerably.

An Example of a Holding Company

A prime example of a well-known holding company is Berkshire
Hathaway, which owns assets in more than one hundred public and
private companies, including Dairy Queen, Clayton Homes, Duracell,
GEICO, Fruit of the Loom, RC Wiley Home Furnishings and Marmon
Group. Berkshire likewise boasts minor holdings in The Coca-Cola
Company, Goldman Sachs, IBM, American Express, Apple, Delta Airlines,
and Kinder Morgan.

3. Private Equity
What is Private Equity?
Private equity is an alternative investment class and consists of capital
that is not listed on a public exchange. Private equity is composed of
funds and investors that directly invest in private companies, or that
engage in buyouts of public companies, resulting in the delisting of public
equity. Institutional and retail investors provide the capital for private
equity, and the capital can be utilized to fund new technology, make
acquisitions, expand working capital, and to bolster and solidify a balance
sheet.
A private equity fund has Limited Partners(LP), who typically own 99
percent of shares in a fund and have limited liability, and General
Partners (GP), who own 1 percent of shares and have full liability. The
latter are also responsible for executing and operating the investment.

Understanding Private Equity

Private equity investment comes primarily from institutional investors
and accredited investors, who can dedicate substantial sums of money
for extended time periods. In most cases, considerably long holding
periods are often required for private equity investments in order to
ensure a turnaround for distressed companies or to enable liquidity
events such as an initial public offering (IPO) or a sale to a public
company.

Advantages of Private Equity

Private equity offers several advantages to companies and startups. It is
favored by companies because it allows them access to liquidity as an
alternative to conventional financial mechanisms, such as high interest
bank loans or listing on public markets. Certain forms of private equity,
such as venture capital, also finance ideas and early stage companies. In
the case of companies that are de-listed, private equity financing can help
such companies attempt unorthodox growth strategies away from the
glare of public markets. Otherwise, the pressure of quarterly earnings
dramatically reduces the time frame available to senior management to
turn a company around or experiment with new ways to cut losses or
make money.

Disadvantages of Private Equity

Private equity comes with its own unique riders. First, it can be difficult to
liquidate holdings in private equity because, unlike public markets, a
ready-made order book that matches buyers with sellers is not available.
A firm has to undertake a search for a buyer in order to make a sale of its
investment or company. Second, pricing of shares for a company in
private equity is determined through negotiations between buyers and
sellers and not by market forces, as is generally the case for publicly-listed
companies. Third, the rights of private equity shareholders are generally
decided on a case-by-case basis through negotiations instead of a broad
governance framework that typically dictates rights for their counterparts
in public markets.

History of Private Equity

While private equity has garnered mainstream spotlight only in the last
three decades, tactics used in the industry have been honed since the
beginning of last century. Banking magnate JP Morgan is said to have
conducted the first leveraged buyout of Carnegie Steel Corporation, then
among the largest producers of steel in the country, for $480 million in
1901. He merged it with other large steel companies of that time, such as
Federal Steel Company and National Tube, to create United States Steel–
the world’s biggest company. It had a market capitalization of $1.4 billion.
However, the Glass Steagall Act of 1933 put an end to such mega-
consolidations engineered by banks.

Private equity firms mostly remained on the sidelines of the financial

ecosystem after World War II until the 1970s when venture capital began
bankrolling America’s technological revolution. Today’s technology
behemoths, including Apple and Intel, got the necessary funds to scale
their business from Silicon Valley’s emerging venture capital ecosystem at
the time of their founding. During the 1970s and 1980s, private equity
firms became a popular avenue for struggling companies to raise funds
away from public markets. Their deals generated headlines and scandals.
With greater awareness of the industry, the amount of capital available
for funds also multiplied and the size of an average transaction in private
equity increased.

When it took place in 1988, conglomerate RJR Nabisco’s purchase by

Kohlberg, Kravis & Roberts (KKR) for $25.1 billion was the biggest
transaction in private equity history. It was eclipsed 19 years later by the
$45 billion buyout of coal plant operator TXU Energy. Goldman Sachs and
TPG Capital joined KKR in raising the required debt to purchase the
company during private equity’s boom years between 2005 and 2007.
Even Warren Buffett bought $2 billion worth of bonds from the new
company. The purchase turned into a bankruptcy seven years later and
Buffett called his investment “a big mistake.”
The boom years for private equity occurred just before the financial crisis
and coincided with an increase in their debt levels. According to a Harvard
study, global private equity groups raised $2 trillion in the years between
2006 and 2008 and each dollar was leveraged by more than two dollars in
debt. But the study found that companies backed by private equity
performed better than their counterparts in the public markets. This was
primarily evident in companies with limited capital at their disposal and
companies whose investors had access to networks and capital that
helped grow their market share.

In the years since the financial crisis, private credit funds have accounted
for an increasing share of business at private equity firms. Such funds
raise money from institutional investors, like pension funds, to provide a
line of credit for companies that are unable to tap the corporate bond
markets. The funds have shorter time periods and terms as compared to
typical PE funds and are among the less regulated parts of the financial
services industry. The funds, which charge high interest rates, are also
less affected by geopolitical concerns, unlike the bond market.

How Does Private Equity Work?

Private equity firms raise money from institutional investors and
accredited investors for funds that invest in different types of assets. The
most popular types of private equity funding are listed below.

Distressed funding: Also known as vulture financing, money in this

type of funding is invested in troubled companies with
underperforming business units or assets. The intention is to turn
them around by making necessary changes to their management or
operations or make a sale of their assets for a profit. Assets in the
latter case can range from physical machinery and real estate to
intellectual property, such as patents. Companies that have filed
under Chapter 11 bankruptcy in the United States are often
candidates for this type of financing. There was an increase in
distressed funding by private equity firms after the 2008 financial
crisis.
Leveraged Buyouts: This is the most popular form of private equity
funding and involves buying out a company completely with the
intention of improving its business and financial health and reselling
it for a profit to an interested party or conducting an IPO. Up until
2004, sale of non-core business units of publicly listed companies
comprised the largest category of leveraged buyouts for private
equity. The leveraged buyout process works as follows. A private
equity firm identifies a potential target and creates a special
purpose vehicle (SPV) for funding the takeover. Typically, firms use a
combination of debt and equity to finance the transaction. Debt
financing may account for as much as 90 percent of the overall
funds and is transferred to the acquired company’s balance sheet
for tax benefits. Private equity firms employ a variety of strategies,
from slashing employee count to replacing entire management
teams, to turn around a company.

Real Estate Private Equity: There was a surge in this type of funding
after the 2008 financial crisis crashed real estate prices. Typical
areas where funds are deployed are commercial real estate and real
estate investment trusts (REIT). Real estate funds require higher
minimum capital for investment as compared to other funding
categories in private equity. Investor funds are also locked away for
several years at a time in this type of funding. According to research
firm Preqin, real estate funds in private equity are expected to clock
in a 50 percent growth by 2023 to reach a market size of $1.2
trillion.

Fund of funds: As the name denotes, this type of funding primarily

focuses on investing in other funds, primarily mutual funds and
hedge funds. They offer a backdoor entry to an investor who cannot
afford minimum capital requirements in such funds. But critics of
such funds point to their higher management fees (because they are
rolled up from multiple funds) and the fact that unfettered
 diversification may not always result in an optimal strategy to
multiply returns.

Venture Capital: Venture capital funding is a form of private equity,

in which investors (also known as angels) provide capital to
entrepreneurs. Depending on the stage at which it is provided,
venture capital can take several forms. Seed financing refers to the
capital provided by an investor to scale an idea from a prototype to
a product or service. On the other hand, early stage financing can
help an entrepreneur grow a company further while a Series A
financing enables them to actively compete in a market or create
one.

How Do Private Equity Firms Make Money?

The primary source of revenue for private equity firms is management
fees. The fee structure for private equity firms typically varies but usually
includes a management fee and a performance fee. Certain firms charge
a 2-percent management fee annually on managed assets and require 20
percent of the profits gained from the sale of a company.

Positions in a private equity firm are highly sought after and for good
reason. For example, consider a firm has $1 billion in assets under
management (AUM). This firm, like the majority of private equity firms, is
likely to have no more than two dozen investment professionals. The 20
percent of gross profits generates millions in firm fees; as a result, some
of the leading players in the investment industry are attracted to
positions in such firms. At a mid-market level of $50 to $500 million in
deal values, associate positions are likely to bring salaries in the low six
figures. A vice president at such a firm could potentially earn close to
$500,000, whereas a principal could earn more than $1 million.

KEY TAKEAWAYS
 Private equity is an alternative form of private financing, away from
public markets, in which funds and investors directly invest in
companies or engage in buyouts of such companies.
  Private equity firms make money by charging management and
performance fees from investors in a fund.
 Among the advantages of private equity are easy access to alternate
forms of capital for entrepreneurs and company founders and less
stress of quarterly performance. Those advantages are offset by the
fact that private equity valuations are not set by market forces.
 Private equity can take on various forms, from complex leveraged
buyouts to venture capital.

Concerns Around Private Equity

Beginning in 2015, a call was issued for more transparency in the private
equity industry due largely to the amount of income, earnings, and sky-
high salaries earned by employees at nearly all private equity firms. As of
2016, a limited number of states have pushed for bills and regulations
allowing for a bigger window into the inner workings of private equity
firms. However, lawmakers on Capitol Hill are pushing back, asking for
limitations on the Securities and Exchange Commission’s (SEC) access to
information.

4. Understanding Private Equity– PE

What Is Private Equity?
The simplest definition of private equity (PE) is that it is equity – that is,
shares representing ownership of or an interest in an entity – that is not
publicly listed or traded. A source ofinvestment capital, private equity
actually derives from high net worth individuals and firms that purchase
shares of private companies or acquire control of public companies with
plans to take them private, eventually become delisting them from public
stock exchanges. Most of the private equity industry is made up of large
institutional investors, such as pension funds, and large private equity
firms funded by a group of accredited investors.

Since the basis of private equity investment is a direct investment into a

firm, often to gain a significant level of influence over the firm's
operations, quite a large capital outlay is required, which is why larger
funds with deep pockets dominate the industry. The minimum amount of
capital required for investors can vary depending on the firm and fund.
Some funds have a $250,000 minimum investment requirement; others
can require millions of dollars.

The underlying motivation for such commitments is, of course, the

pursuit of achieving a positive return on investment. Partners at private-
equity firms raise funds and manage these monies to yield favorable
returns for their shareholder clients, typically with an investment horizon
between four and seven years.

The Private Equity Profession

Private equity has successfully attracted the best and brightest in
corporate America, including top performers from Fortune 500
companies and elite strategy and management consulting firms. Top
performers at accounting and law firms can also be recruiting grounds, as
accounting and legal skills relate to transaction support work required to
complete a deal and translate to advisory work for a portfolio company's
management.

The fee structure for private-equity firms varies, but it typically consists of
a management fee and a performance fee (in some cases, a yearly
management fee of 2% of assets managed and 20% of gross profits upon
sale of the company). How firms are incentivized can vary considerably.

Given that a private-equity firm with $1 billion of assets under

management might have no more than two dozen investment
professionals, and that 20% of gross profits can generate tens of millions
of dollars in fees for the firm, it is easy to see why the private-equity
industry has attracted top talent. At the middle market level ($50 million
to $500 million in deal value), associates can earn low six figures in salary
and bonuses, vice presidents can earn approximately half a million
dollars and principals can earn more than $1 million in (realized and
unrealized) compensation per year.
Types of Private-Equity Firms
A spectrum of investing preferences spans across the thousands of
private-equity firms in existence. Some are strict financiers – passive
investors – who are wholly dependent on management to grow the
company (and its profitability) and supply their owners with appropriate
returns. Because sellers typically see this method as a commoditized
approach, other private-equity firms consider themselves active
investors. That is, they provide operational support to management to
help build and grow a better company.

These types of firms may have an extensive contact list and "C-level"
relationships, such as CEOs and CFOs within a given industry, which can
help increase revenue, or they may be experts in realizing operational
efficiencies and synergies. If an investor can bring in something special to
a deal that will enhance the company's value over time, such an investor
is more likely to be viewed favorably by sellers. It is the seller who
ultimately chooses whom they want to sell to or partner with.

Investment banks compete with private-equity firms (also known as

private equity funds) in buying up good companies and financing to
nascent ones. It is no surprise that the largest investment-banking
entities, such as Goldman Sachs (GS), JPMorgan Chase (JPM) and Citigroup
(C), often facilitate the largest deals.

In the case of private-equity firms, the funds they offer are only accessible
to accredited investors and may only have a limited number of investors,
while the fund's founders will often take a rather large stake in the firm as
well. However, some of the largest and most prestigious private equity
funds trade their shares publicly. For instance, the Blackstone Group (BX)
trades on the NYSE and has been involved in the buyouts of companies
such as Hilton Hotels and SunGard.

How Private Equity Creates Value

Private-equity firms perform two critical functions:

deal origination/transaction execution

portfolio oversight
Deal origination involves creating, maintaining and developing
relationships with mergers and acquisitions (M&A) intermediaries,
investment banks and similar transaction professionals to secure both
high-quantity and high-quality deal flow. Deal flow refers to prospective
acquisition candidates referred to private-equity professionals for
investment review. Some firms hire internal staff to proactively identify
and reach out to company owners to generate transaction leads. In a
competitive M&A landscape, sourcing proprietary deals can help ensure
that the funds raised are successfully deployed and invested.

Additionally, internal sourcing efforts can reduce transaction-related costs

by cutting out the investment banking middleman's fees. When financial
services professionals represent the seller, they usually run a full auction
process that can diminish the buyer's chances of successfully acquiring a
particular company. As such, deal origination professionals (typically at
the associate, vice president, and director levels) attempt to establish a
strong rapport with transaction professionals to get an early introduction
to a deal.

It is important to note that investment banks often raise their own funds,
and therefore may not only be a deal referral, but also a competing
bidder. In other words, some investment banks compete with private-
equity firms in buying up good companies.

Transaction execution involves assessing management, the industry,

historical financials and forecasts, and conducting valuation analyses.
After the investment committee signs off to pursue a target acquisition
candidate, the deal professionals submit an offer to the seller. If both
parties decide to move forward, the deal professionals work with various
transaction advisors to include investment bankers, accountants, lawyers
and consultants to execute the due diligence phase. Due diligence
includes validating management's stated operational and financial
figures. This part of the process is critical, as consultants can uncover deal
killers, such as significant and previously undisclosed liabilities and risks.
Private Equity Investment Strategies
When it comes to doing the deal, private equity investment strategies are
numerous; two of the most common are leveraged buyouts and venture
capital investments.

Leveraged buyouts are exactly how they sound: a target firm is bought
out by a private equity firm (or as a part of a larger group of firms). The
purchase is financed (or leveraged) through debt, which is collateralized
by the target firm's operations and assets. The acquirer (the PE firm)
seeks to purchase the target with funds acquired through the use of the
target as a sort of collateral.

In essence, in a leveraged buyout, acquiring PE firms are able to purchase

companies with only having to put up a fraction of the purchase price. By
leveraging the investment, PE firms aim to maximize their potential
return, always of the utmost importance for firms in the industry.

Venture capital is a more general term, most often used in relation to

taking an equity investment in a young firm in a less mature industry
(think internet firms in the early to mid-1990s). Quite often PE firms will
see that potential exists in the industry and more importantly the target
firm itself, and often due to the lack of revenues, cash flow and debt
financing available to the target, PE firms are able to take significant
stakes in such companies in the hopes that the target will evolve into a
powerhouse in its growing industry. Additionally, by guiding the target
firm's often inexperienced management along the way, private equity
firms add value to the firm in a less quantifiable manner as well.

Oversight and Management

Which leads us to the second important function of private-equity
professionals: oversight and support of the firm's various portfolio
companies and their management teams. Among other support work,
they can walk a young company's executive staff through best practices in
strategic planning and financial management. Additionally, they can help
institutionalize new accounting, procurement, and IT systems to increase
the value of their investment.
When it comes to more established companies, PE firms believe they
have the ability and expertise to take underperforming businesses and
turn them into stronger ones by increasing operational efficiencies, which
increases earnings. This is the primary source of value creation in private
equity, though PE firms also create value by aiming to align the interests
of company management with those of the firm and its investors. By
taking public companies private, PE firms remove the constant public
scrutiny of quarterly earnings and reporting requirements, which then
allows the PE firm and the acquired firm's management to take a longer-
term approach in bettering the fortunes of the company.

Also, management compensation is frequently tied more closely to the

firm's performance, thus adding accountability and incentive to
management's efforts. This, along with other mechanisms popular in the
private equity industry (hopefully) eventually lead to the acquired firm's
valuation increasing substantially in value from the time it was purchased,
creating a profitable exit strategy for the PE firm – whether that be resale,
an IPO or another option.

Investing in Upside
One popular exit strategy for private equity involves growing and
improving a middle-market company and selling it to a large corporation
(within a related industry) for a hefty profit. The bigninvestment banking
professionals cited above typically focus their efforts on deals with
enterprise values worth billions of dollars. However, the vast majority of
transactions reside in the middle market ($50 million to $500 million
deals) and lower-middle market ($10 million to $50 million deals).
Because the best gravitate toward the larger deals, the middle market is a
significantly underserved market: That is, there are significantly more
sellers than there are highly seasoned and positioned finance
professionals with the extensive buyer networks and resources to
manage a deal (for middle-market company owners).

Flying below the radar of large multinational corporations, many of these

small companies often provide higher-quality customer service, and/or
niche products and services that are not being offered by the large
conglomerates. Such upsides attract the interest of private-equity firms,
as they possess the insights and savvy to exploit such opportunities and
take the company to the next level.

For instance, a small company selling products within a particular region

might significantly grow by cultivating international sales channels. Or a
highly fragmented industry can undergo consolidation (with the private-
equity firm buying up and combining these entities) to create fewer,
larger players. Larger companies typically command higher valuations
than smaller companies.

An important company metric for these investors is earnings before

interest, taxes, depreciation, and amortization (EBITDA). When a private-
equity firm acquires a company, they work together with management to
significantly increase EBITDA during its investment horizon (typically
between four and seven years). A good portfolio company can typically
increase its EBITDA both organically (internal growth) and by acquisitions.

It is critical for private-equity investors to have reliable, capable and

dependable management in place. Most managers at portfolio
companies are given equity and bonus compensation structures that
reward them for hitting their financial targets. Such alignment of goals
(and appropriate compensation structuring) is typically required before a
deal gets done.

Investing in Private Equity

For investors who are not in a position to put forth millions of dollars,
private equity is often ruled out of a portfolio – but it shouldn't be.
Though most private equity investment opportunities require steep initial
investments, there are still some ways for smaller fry to play.

There are several private equity investment firms, aka called business
development companies, who offer publicly traded stock, giving average
investors the opportunity to own a slice of the private equity pie. Along
with the Blackstone Group (mentioned above), examples of these stocks
are Apollo Global Management LLC (APO), Carlyle Group (CG) and
Kohlberg Kravis Roberts/ KKR & Co. (KKR), best known for its massive
leveraged buyout of RJR Nabisco in 1989.
Mutual funds have restrictions in terms of buying private equity due to
the SEC's rules regarding illiquid securities holdings, but they can invest
indirectly by buying these publicly listed private equity companies, too;
these mutual funds are typically referred to as funds of funds.
Additionally, average investors can purchase shares of an exchange-
traded fund (ETF) that holds shares of private equity companies, such as
ProShares Global Listed Private Equity ETF (PEX).

The Bottom Line

With funds under management already in the trillions, private-equity
firms have become attractive investment vehicles for wealthy individuals
and institutions. Understanding what private equity exactly entails and
how its value is created in such investments are the first steps in entering
an asset class that is gradually becoming more accessible to individual
investors.

As the industry attracts the best and brightest in corporate America, the
professionals at private-equity firms are usually successful in deploying
investment capital and in increasing the values of their portfolio
companies. However, there is also fierce competition in the M&A
marketplace for good companies to buy. As such, it is imperative that
these firms develop strong relationships with transaction and services
professionals to secure strong deal flow.

5. Hedge Fund
What Is a Hedge Fund?
Hedge funds are alternative investments using pooled funds that employ
different strategies to earn active return, or alpha, for their investors.
Hedge funds may be aggressively managed or make use of derivatives
and leverage in both domestic and international markets with the goal of
generating high returns (either in an absolute sense or over a specified
market benchmark). It is important to note that hedge funds are generally
only accessible to accredited investors as they require less SEC
regulations than other funds. One aspect that has set the hedge fund
industry apart is the fact that hedge funds face less regulation than
mutual funds and other investment vehicles.
Understanding Hedge Funds
Each hedge fund is constructed to take advantage of certain identifiable
market opportunities. Hedge funds use different investment strategies
and thus are often classified according to investment style. There is
substantial diversity in risk attributes and investments among styles.

Legally, hedge funds are most often set up as private investment limited
partnerships that are open to a limited number of accredited investors
and require a large initial minimum investment. Investments in hedge
funds are illiquid as they often require investors to keep their money in
the fund for at least one year, a time known as the lock-up period.
Withdrawals may also only happen at certain intervals such as quarterly
or bi-annually.

KEY TAKEAWAYS
 Hedge funds are alternative investment vehicles that employ a
variety of strategies to generate alpha for their accredited investor
clients.
 They are more expensive as compared to conventional investment
instruments because they have a Two And Twenty fee structure,
meaning they charge two percent for asset management and take
20% of overall profits as fees.
 They have had an exceptional growth curve in the last twenty years
and have been associated with several controversies.

The History of the Hedge Fund

A former writer and sociologist Alfred Winslow Jones’s company, A.W.
Jones & Co. launched the first hedge fund in 1949. It was while writing an
article about current investment trends for Fortune in 1948 that Jones
was inspired to try his hand at managing money. He raised $100,000
(including $40,000 out of his own pocket) and set forth to try to minimize
the risk in holding long-term stock positions by short selling other stocks.
This investing innovation is now referred to as the classic long/short
equities model. Jones also employed leverage to enhance returns.

In 1952, Jones altered the structure of his investment vehicle, converting it

from a general partnership to a limited partnership and adding a 20%
incentive fee as compensation for the managing partner. As the first
money manager to combine short selling, the use of leverage shared risk
through a partnership with other investors and a compensation system
based on investment performance, Jones earned his place in investing
history as the father of the hedge fund.

Hedge funds went on to dramatically outperform most mutual funds in

the 1960s and gained further popularity when a 1966 article in Fortune
highlighted an obscure investment that outperformed every mutual fund
on the market by double-digit figures over the previous year and by high
double-digits over the previous five years.

However, as hedge fund trends evolved, in an effort to maximize returns,

many funds turned away from Jones' strategy, which focused on stock
picking coupled with hedging and chose instead to engage in riskier
strategies based on long-term leverage. These tactics led to heavy losses
in 1969-70, followed by a number of hedge fund closures during the bear
market of 1973-74.

The industry was relatively quiet for more than two decades until a 1986
article in Institutional Investor touted the double-digit performance of
Julian Robertson's Tiger Fund. With a high-flying hedge fund once again
capturing the public's attention with its stellar performance, investors
flocked to an industry that now offered thousands of funds and an ever-
increasing array of exotic strategies, including currency trading and
derivatives such as futures and options.

High-profile money managers deserted the traditional mutual fund

industry in droves in the early 1990s, seeking fame and fortune as hedge
fund managers. Unfortunately, history repeated itself in the late 1990s
and into the early 2000s as a number of high-profile hedge funds,
including Robertson's, failed in spectacular fashion. Since that era, the
hedge fund industry has grown substantially. Today the hedge fund
industry is massive—total assets under management in the industry are
valued at more than $3.2 trillion according to the 2018 Preqin Global
Hedge Fund Report. Based on statistics from research firm Barclays
hedge, the total number of assets under management for hedge funds
jumped by 2335% between 1997 and 2018.

The number of operating hedge funds has grown as well. There were
around 2,000 hedge funds in 2002. Estimates vary about the number of
hedge funds operating today. This number had crossed 10,000 by the end
of 2015. However, losses and underperformance led to liquidations. By
the end of 2017, there are 9754 hedge funds according to research firm
Hedge Fund Research.

Key Characteristics

They're only open to "accredited" or qualified investors: Hedge

funds are only allowed to take money from "qualified" investors—
individuals with an annual income that exceeds $200,000 for the
past two years or a net worth exceeding $1 million, excluding their
primary residence. As such, the Securities and Exchange
Commission deems qualified investors suitable enough to handle
the potential risks that come from a wider investment mandate.

They offer wider investment latitude than other funds: A hedge

fund's investment universe is only limited by its mandate. A hedge
fund can basically invest in anything—land, real estate, stocks,
derivatives, and currencies. Mutual funds, by contrast, have to
basically stick to stocks or bonds and are usually long-only.

They often employ leverage: Hedge funds will often use borrowed
money to amplify their returns. As we saw during the financial crisis
of 2008, leverage can also wipe out hedge funds.

Fee structure: Instead of charging an expense ratio only, hedge

funds charge both an expense ratio and a performance fee. This fee
structure is known as "Two and Twenty"—a 2% asset management
fee and then a 20% cut of any gains generated.
There are more specific characteristics that define a hedge fund, but
basically, because they are private investment vehicles that only allow
wealthy individuals to invest, hedge funds can pretty much do what they
want as long as they disclose the strategy upfront to investors. This wide
latitude may sound very risky, and at times it can be. Some of the most
spectacular financial blow-ups have involved hedge funds. That said, this
flexibility afforded to hedge funds has led to some of the most talented
money managers producing some amazing long-term returns.

It is important to note that "hedging" is actually the practice of attempting

to reduce risk, but the goal of most hedge funds is to maximize return on
investment. The name is mostly historical, as the first hedge funds tried to
hedge against the downside risk of a bear market by shorting the market.
(Mutual funds generally don't enter into short positions as one of their
primary goals). Nowadays, hedge funds use dozens of different strategies,
so it isn't accurate to say that hedge funds just "hedge risk." In fact,
because hedge fund managers make speculative investments, these
funds can carry more risk than the overall market.

Below are some of the risks of hedge funds:

Concentrated investment strategy exposes hedge funds to

potentially huge losses.

Hedge funds typically require investors to lock up money for a

period of years.

Use of leverage, or borrowed money, can turn what would have

been a minor loss into a significant loss.

Hedge Fund Manager Pay Structure

Hedge fund managers are notorious for their typical 2 and 20 pay
structure whereby the fund manager receives 2% of assets and 20% of
profits each year. It's the 2% that gets the criticism, and it's not difficult to
see why. Even if the hedge fund manager loses money, he still gets 2% of
assets. For example, a manager overseeing a $1 billion fund could pocket
$20 million a year in compensation without lifting a finger.

That said, there are mechanisms put in place to help protect those who
invest in hedge funds. Often times, fee limitations such as high-water
marks are employed to prevent portfolio managers from getting paid on
the same returns twice. Fee caps may also be in place to prevent
managers from taking on excess risk.

How to Pick a Hedge Fund

With so many hedge funds in the investment universe, it is important that
investors know what they are looking for in order to streamline the due
diligence process and make timely and appropriate decisions.

When looking for a high-quality hedge fund, it is important for an investor

to identify the metrics that are important to them and the results
required for each. These guidelines can be based on absolute values,
such as returns that exceed 20% per year over the previous five years, or
they can be relative, such as the top five highest-performing funds in a
particular category.

Fund Absolute Performance Guidelines

The first guideline an investor should set when selecting a fund is the
annualized rate of return. Let's say that we want to find funds with a five-
year annualized return that exceeds the return on the Citigroup World
Government Bond Index (WGBI) by 1%. This filter would eliminate all
funds that underperform the index over long time periods, and it could
be adjusted based on the performance of the index over time.

This guideline will also reveal funds with much higher expected returns,
such as global macro funds, long-biased long/short funds, and several
others. But if these aren't the types of funds the investor is looking for,
then they must also establish a guideline for standard deviation. Once
again, we will use the WGBI to calculate the standard deviation for the
index over the previous five years. Let's assume we add 1% to this result,
and establish that value as the guideline for standard deviation. Funds
with a standard deviation greater than the guideline can also be
eliminated from further consideration.

Unfortunately, high returns do not necessarily help to identify an

attractive fund. In some cases, a hedge fund may have employed a
strategy that was in favor, which drove performance to be higher than
normal for its category. Therefore, once certain funds have been
identified as high-return performers, it is important to identify the fund's
strategy and compare its returns to other funds in the same category. To
do this, an investor can establish guidelines by first generating a peer
analysis of similar funds. For example, one might establish the 50 th
percentile as the guideline for filtering funds.

Now an investor has two guidelines that all funds need to meet for
further consideration. However, applying these two guidelines still leaves
too many funds to evaluate in a reasonable amount of time. Additional
guidelines need to be established, but the additional guidelines will not
necessarily apply across the remaining universe of funds. For example,
the guidelines for a merger arbitrage fund will differ from those for a
long-short market-neutral fund.

Fund Relative Performance Guidelines

To facilitate the investor's search for high-quality funds that not only meet
the initial return and risk guidelines but also meet strategy-specific
guidelines, the next step is to establish a set of relative guidelines.
Relative performance metrics should always be based on specific
categories or strategies. For example, it would not be fair to compare a
leveraged global macro fund with a market-neutral, long/short equity
fund.

To establish guidelines for a specific strategy, an investor can use an

analytical software package (such as Morningstar) to first identify a
universe of funds using similar strategies. Then, a peer analysis will reveal
many statistics, broken down into quartiles or deciles, for that universe.

The threshold for each guideline may be the result for each metric that
meets or exceeds the 50th percentile. An investor can loosen the
guidelines by using the 60th percentile or tighten the guideline by using
the 40th percentile. Using the 50th percentile across all the metrics usually
filters out all but a few hedge funds for additional consideration. In
addition, establishing the guidelines this way allows for flexibility to adjust
the guidelines as the economic environment may impact the absolute
returns for some strategies.

Here is a sound list of primary metrics to use for setting guidelines:

Five-year annualized returns

Standard deviation

Rolling standard deviation

Months to recovery/maximum drawdown

Downside deviation

These guidelines will help eliminate many of the funds in the universe
and identify a workable number of funds for further analysis.

Other Fund Consideration Guidelines

An investor may also want to consider other guidelines that can either
further reduce the number of funds to analyze or to identify funds that
meet additional criteria that may be relevant to the investor. Some
examples of other guidelines include:

Fund Size/Firm Size: The guideline for size may be a minimum or

maximum depending on the investor's preference. For example,
institutional investors often invest such large amounts that a fund
or firm must have a minimum size to accommodate a large
investment. For other investors, a fund that is too big may face
future challenges using the same strategy to match past successes.
Such might be the case for hedge funds that invest in the small-cap
equity space.

Track Record: If an investor wants a fund to have a minimum track

record of 24 or 36 months, this guideline will eliminate any new
 funds. However, sometimes a fund manager will leave to start their
own fund and although the fund is new, the manager's performance
can be tracked for a much longer time period.

Minimum Investment: This criterion is very important for smaller

investors as many funds have minimums that can make it difficult to
diversify properly. The fund's minimum investment can also give an
indication of the types of investors in the fund. Larger minimums
may indicate a higher proportion of institutional investors, while low
minimums may indicate a larger number of individual investors.

Redemption Terms: These terms have implications for liquidity and

become very important when an overall portfolio is highly illiquid.
Longer lock-up periods are more difficult to incorporate into a
portfolio, and redemption periods longer than a month can present
some challenges during the portfolio-management process. A
guideline may be implemented to eliminate funds that have lockups
when a portfolio is already illiquid, while this guideline may be
relaxed when a portfolio has adequate liquidity.

Taxing Hedge Fund Profits

When a domestic U.S. hedge fund returns profits to its investors, the
money is subject to capital gains tax. The short-term capital gains rate
applies to profits on investments held for less than one year, and it is the
same as the investor's tax rate on ordinary income. For investments held
for more than one year, the rate is not more than 15% for most
taxpayers, but it can go as high as 20% in high tax brackets. This tax
applies to both U.S. and foreign investors.

An offshore hedge fund is established outside of the United States,

usually in a low-tax or tax-free country. It accepts investments from
foreign investors and tax-exempt U.S. entities. These investors do not
incur any U.S. tax liability on the distributed profits.
Ways Hedge Funds Avoid Taxes
Many hedge funds are structured to take advantage of carried interest.
Under this structure, a fund is treated as a partnership. The founders and
fund managers are the general partners, while the investors are the
limited partners. The founders also own the management company that
runs the hedge fund. The managers earn the 20% performance fee of the
carried interest as the general partner of the fund.

Hedge fund managers are compensated with this carried interest; their
income from the fund is taxed as a return on investments as opposed to
a salary or compensation for services rendered. The incentive fee is taxed
at the long-term capital gains rate of 20% as opposed to ordinary income
tax rates, where the top rate is 39.6%. This represents significant tax
savings for hedge fund managers.

This business arrangement has its critics, who say that the structure is a
loophole that allows hedge funds to avoid paying taxes. The carried
interest rule has not yet been overturned despite multiple attempts in
Congress. It became a topical issue during the 2016 primary election.

Many prominent hedge funds use reinsurance businesses in Bermuda as

another way to reduce their tax liabilities. Bermuda does not charge
a corporate income tax, so hedge funds set up their own reinsurance
companies in Bermuda. The hedge funds then send money to the
reinsurance companies in Bermuda. These reinsurers, in turn, invest
those funds back into the hedge funds. Any profits from the hedge funds
go to the reinsurers in Bermuda, where they owe no corporate income
tax. The profits from the hedge fund investments grow without any tax
liability. Taxes are only owed once the investors sell their stakes in the
reinsurers.

The business in Bermuda must be an insurance business. Any other type

of business would likely incur penalties from the U.S. Internal Revenue
Service (IRS) for passive foreign investment companies. The IRS defines
insurance as an active business. To qualify as an active business, the
reinsurance company cannot have a pool of capital that is much larger
than what it needs to back the insurance that it sells. It is unclear what
this standard is, as it has not yet been defined by the IRS.
Hedge Fund Controversies
A number of hedge funds have been implicated in insider trading
scandals since 2008. One of the most high-profile insider trading cases
involves the Galleon Group managed by Raj Rajaratnam.

The Galleon Group managed over $7 billion at its peak before being
forced to close in 2009. The firm was founded in 1997 by Raj Rajaratnam.
In 2009, federal prosecutors charged Rajaratnam with multiple counts of
fraud and insider trading. He was convicted on 14 charges in 2011 and
began serving an 11-year sentence. Many Galleon Group employees were
also convicted in the scandal.

Rajaratnam was caught obtaining insider information from Rajat Gupta, a

board member of Goldman Sachs. Before the news was made public,
Gupta allegedly passed on information that Warren Buffett was making
an investment in Goldman Sachs in September 2008 at the height of the
financial crisis. Rajaratnam was able to buy substantial amounts of
Goldman Sachs stock and make a hefty profit on those shares in one day.

Rajaratnam was also convicted on other insider trading charges.

Throughout his tenure as a fund manager, he cultivated a group of
industry insiders to gain access to material information.

Regulations for Hedge Funds

Hedge funds are so big and powerful that the SEC is starting to pay closer
attention, particularly because breaches such as insider trading and fraud
seem to be occurring much more frequently. However, a recent act has
actually loosened the way that hedge funds can market their vehicles to
investors.

In March 2012, the Jumpstart Our Business Startups Act (JOBS Act) was
signed into law. The basic premise of the JOBS Act was to encourage
funding of small businesses in the U.S. by easing securities regulation.
The JOBS Act also had a major impact on hedge funds: In September
2013, the ban on hedge fund advertising was lifted. In a 4-to-1 vote, the
SEC approved a motion to allow hedge funds and other firms that create
private offerings to advertise to whomever they want, but they still can
only accept investments from accredited investors. Hedge funds are often
key suppliers of capital to startups and small businesses because of their
wide investment latitude. Giving hedge funds the opportunity to solicit
capital would in effect help the growth of small businesses by increasing
the pool of available investment capital.

Hedge fund advertising entails offering the fund's investment products to

accredited investors or financial intermediaries through print, television
and the internet. A hedge fund that wants to solicit (advertise to)
investors must file a “Form D” with the SEC at least 15 days before it starts
advertising. Because hedge fund advertising was strictly prohibited prior
to lifting this ban, the SEC is very interested in how advertising is being
used by private issuers, so it has made changes to Form D filings. Funds
that make public solicitations will also need to file an amended Form D
within 30 days of the offering’s termination. Failure to follow these rules
will likely result in a ban from creating additional securities for a year or
more.

Post-2008: Chasing the S&P

Since the 2008 crisis, the hedge fund world has entered into another
period of less-than-stellar returns. Many funds which previously enjoyed
double-digit returns during an average year have seen their profits
diminish significantly. In many cases, funds have failed to match the
returns of the S&P 500. For investors considering where to place their
money, this becomes an increasingly easy decision: why suffer the high
fees and initial investments, the added risk, and the withdrawal
limitations of hedge funds if a safer, simpler investment like a mutual
fund can produce returns that are the same or, in some cases, even
stronger?

There are many reasons why hedge funds have struggled in recent years.
These reasons run the gauntlet from geopolitical tensions around the
globe to an over-reliance among many funds on particular sectors,
including technology, and interest rate hikes by the Fed. Many prominent
fund managers have made highly-publicized bad bets which have cost
them not only monetarily but in terms of their reputations as savvy fund
leaders, too.

David Einhorn is an example of this approach. Einhorn's firm Greenlight

Capital bet against Allied Capital early on and Lehman Brothers during
the financial crisis. Those high-profile bets were successful and earned
Einhorn the reputation of a shrewd investor.

However, the firm posted losses of 34 percent, its worst year ever, in 2018
on the back of shorts against Amazon, which recently became the second
trillion dollar company after Apple, and holdings in General Motors, which
posted a less-than-stellar 2018.

Notably, the overall size of the hedge fund industry (in terms of assets
under management) has not declined significantly during this period and
has continued to grow. There are new hedge funds launching all the time,
even as several of the past 10 years have seen record numbers of hedge
fund closures.

In the midst of growing pressures, some hedge funds are reevaluating

aspects of their organization, including the "Two and Twenty" fee
structure. According to data from Hedge Fund Research, the last quarter
of 2016 saw the average management fee fall to 1.48%, while the average
incentive fee fell to 17.4%. In this sense, the average hedge fund is still
much more costly than, say, an index or mutual fund, but the fact that the
fee structure is changing on average is notable.

Major Hedge Funds

In mid-2018, data provider HFM Absolute Return created a ranked list of
hedge funds according to total AUM. This list of top hedge funds includes
some companies which hold more in AUM in other areas besides a hedge
fund arm. Nonetheless, the ranking factors in only the hedge fund
operations at each firm.

Paul Singer's Elliott Management Corporation held $35 billion in AUM as

of the survey. Founded in 1977, the fund is occasionally described as a
"vulture fund," as roughly one-third of its assets are focused on
distressed securities, including debt for bankrupt countries. Regardless,
the strategy has proven successful for multiple decades.

Founded in 2001 by David Siegel and John Overdeck, New York's Two
Sigma Investments is near the top of the list of hedge funds by AUM, with
more than $37 billion in managed assets. The firm was designed to not
rely on a single investment strategy, allowing it to be flexible along with
shifts in the market.

One of the most popular hedge funds in the world is James H. Simon's
Renaissance Technologies. The fund, with $57 billion in AUM, was
launched in 1982, but it has revolutionized its strategy along with changes
in technology in recent years. Now, Renaissance is known for systematic
trading based on computer models and quantitative algorithms. Thanks
to these approaches, Renaissance has been able to provide investors with
consistently strong returns, even in spite of recent turbulence in the
hedge fund space more broadly.

AQR Capital Investments is the second-largest hedge fund in the world,

overseeing just under $90 billion in AUM as of the time of HFM's survey.
Based in Greenwich, Connecticut, AQR is known for utilizing both
traditional and alternative investment strategies.

Ray Dalio's Bridgewater Associates remains the largest hedge fund in the
world, with just under $125 billion in AUM as of mid-2018. The
Connecticut-based fund employs about 1700 people and focuses on a
global macro investing strategy. Bridgewater counts foundations,
endowments, and even foreign governments and central banks among its
clientele.

6. Hedge Fund vs Private Equity Fund: What's the

Difference?
Hedge Fund vs. Private Equity Fund: An Overview
Although their investor profiles are often similar, there are significant
differences between the aims and types of investments sought by hedge
funds and private equity funds.
Both hedge funds and private equity funds appeal to high-net-worth
individuals (many require minimum investments of $250,000 or more),
traditionally are structured as limited partnerships, and involve paying
the managing partners basic management fees plus a percentage of
profits.

Hedge Fund
Hedge funds are alternative investments that use pooled funds and
employ a variety of strategies to earn returns for their investors. The aim
of a hedge fund is to provide the highest investment returns possible as
quickly as possible. To achieve this goal, hedge fund investments are
primarily in highly liquid assets, enabling the fund to take profits quickly
on one investment and then shift funds into another investment that is
more immediately promising. Hedge funds tend to use leverage, or
borrowed money, to increase their returns. But such strategies are risky
—highly leveraged firms were hit hard during the 2008 financial crisis.

Hedge funds invest in virtually anything and everything—individual stocks

(including short selling and options), bonds, commodity futures,
currencies, arbitrage, derivatives—whatever the fund manager sees as
offering high potential returns in a short period of time. The focus of
hedge funds is on maximum short-term profits.

Hedge funds are rarely accessible to the majority of investors; instead,

hedge funds are geared toward accredited investors, as they need less
SEC regulation than other funds. An accredited investor is a person or a
business entity who is allowed to deal in securities that may not be
registered with financial authorities. Hedge funds are also notoriously
less regulated than mutual funds and other investment vehicles.

In terms of costs, hedge funds are pricier to invest in than mutual funds
or other investment vehicles. Instead of charging an expense ratio only,
hedge funds charge both an expense ratio and a performance fee.
Private Equity Fund
Private equity funds more closely resemble venture capital firms in that
they invest directly in companies, primarily by purchasing private
companies, although they sometimes seek to acquire controlling interest
in publicly traded companies through stock purchases. They frequently
use leveraged buyouts to acquire financially distressed companies.

Unlike hedge funds focused on short-term profits, private equity funds

are focused on the long-term potential of the portfolio of companies they
hold an interest in or acquire.

Important: Once they acquire or control interest in a company, private

equity funds look to improve the company through management
changes, streamlining operations, or expansion, with the eventual goal of
selling the company for a profit, either privately or through an initial
public offering in a stock market.

To achieve their aims, private equity funds usually have, in addition to the
fund manager, a group of corporate experts who can be assigned to
manage the acquired companies. The very nature of their investments
requires their more long-term focus, looking for profits on investments to
mature in a few years rather having the short-term quick profit focus of
hedge funds.

Key Differences
Since hedge funds are focused on primarily liquid assets, investors can
usually cash out their investments in the fund at any time. In contrast, the
long-term focus of private equity funds usually dictates a requirement
that investors commit their funds for a minimum period of time, usually
at least three to five years, and often from seven to 10 years.

There is also a substantial difference in risk level between hedge funds

and private equity funds. While both practice risk management by
combining higher-risk investments with safer investments, the focus of
hedge funds on achieving maximum short-term profits necessarily
involves accepting a higher level of risk.
There are hedge funds that fit the classic definition—funds designed to
provide protection of capital invested in traditional investments—but that
is no longer considered the common usage of the term.

KEY TAKEAWAYS
 Hedge funds and private equity funds appeal to high-net-worth
individuals.
 Both types of funds involve paying managing partners basic fees
plus a percentage of profits.
 Hedge funds are alternative investments that use pooled money
and a variety of tactics to earn returns for their investors.
 Private equity funds invest directly in companies, by either
purchasing private firms or buying a controlling interest in publicly
traded companies.

7. Asset Management Company (AMC)

What Is an Asset Management Company (AMC)?
An asset management company (AMC) is a firm that invests pooled funds
from clients, putting the capital to work through different investments
including stocks, bonds, real estate, master limited partnerships, and
more. Along with high-net-worth individual portfolios, AMCs manage
hedge funds and pension plans, and—to better serve smaller investors—
create pooled structures such as mutual funds, index funds, or exchange-
traded funds, which they can manage in a single centralized portfolio.

Asset management companies are colloquially referred to as money

managers or money management firms. Those that offer public mutual
funds or exchange-traded funds (ETFs) are also known as investment
companies or mutual fund companies. Such businesses include Vanguard
Group, Fidelity Investments, T. Rowe Price, and many others.

KEY TAKEAWAYS
 An asset management company (AMC) invests pooled funds from
clients into a variety of securities and assets.
  AMCs range from personal money managers, handling high-net-
worth individual accounts, to large investment companies
sponsoring mutual funds.
 AMC managers are compensated via fees, usually a percentage of a
client's assets under management.
 Most AMCs are held to a fiduciary standard.

Understanding AMCs
Because they have a larger pool of resources than the individual investor
could access on their own, asset management companies provide
investors with more diversification and investing options. Buying for so
many clients allows AMCs to practice economies of scale, often getting a
price discount on their purchases. Pooling assets and paying out
proportional returns also allow investors to avoid the minimum
investment requirements often required when purchasing securities on
their own, as well as the ability to invest in a larger assortment of
securities with a smaller amount of investment funds.

In some cases, AMCs charge their investors set fees. In other cases, these
companies charge a fee that is calculated as a percentage of the client's
total assets under management (AUM). For example, if an AMC is
overseeing a portfolio worth $4 million, and the AMC charges a 2% fee, it
owns $80,000 of that investment. If the value of the investment increases
to $5 million, the AMC owns $100,000, and if the value falls, so too does
the AMC's stake. Some AMCs combine flat service fees and percentage-
based fees.

Typically, AMCs are considered buy-side firms. This status means they
help their clients buy investments. They decide what to buy based on in-
house research and data analytics, but they also take public
recommendations from sell-side firms.

Sell-side firms such as investment banks and stockbrokers, in contrast,

sell investment services to AMCs and other investors. They perform a
great deal of market analysis, looking at trends and creating projections.
 Their objective is to generate trade orders on which they can charge
transaction fees or commissions.

AMCs vs. Brokerage Houses

Brokerage houses and asset management companies overlap in many
ways. Along with trading securities and doing analysis, many brokers
advise and manage client portfolios, often through a special "private
investment" or "wealth management" division or subsidiary. Many also
offer proprietary mutual funds. Their brokers may also act as advisors to
clients, discussing financial goals, recommending products, and assisting
clients in other ways.

In general, though, brokerage houses accept nearly any client, regardless

of the amount they have to invest, and these companies have a legal
standard to provide "suitable" services. Suitable essentially means that as
long as they make their best effort to manage the fund wisely, and in line
with their clients' stated goals, they are not responsible if their clients lose
money.

In contrast, most asset management firms are fiduciary firms, held to a

higher legal standard. Essentially, fiduciaries must act in the best interest
of their clients, avoiding conflicts of interest at all times. If they fail to do
so, they face criminal liability. They're held to this higher standard in large
part because money managers usually have discretionary trading powers
over accounts. That is, they can buy, sell, and make investment decisions
on their authority, without consulting the client first. In contrast, brokers
must ask permission before executing trades.

Asset management companies usually execute their trades through a

designated broker. That brokerage also acts as the designated custodian
that holds or houses an investor's account. AMCs also tend to have higher
minimum investment thresholds than brokerages do, and they charge
fees rather than commissions.

Pros
 Professional, legally liable management
 Portfolio diversification

 Greater investment options

 Economies of scale

Cons
 Sizeable management fees

 High account minimums

 Risk of underperforming the market

Real-World Example of an AMC

As mentioned earlier, purveyors of popular mutual fund families are
technically asset management companies. Also, many high-profile banks
and brokerages have asset management divisions, usually for high-net-
worth individuals or institutions.

But there are also private asset management companies that are not
household names but are quite established in the investment field. One
such example is RMB Capital, an independent investment and advisory
firm with approximately $8.8 billion in assets under management.
Headquartered in Chicago, with 10 other offices around the U.S., and 190
employees, RMB has three divisions:

1.RMB Wealth Management for wealthy retail investors

2.RMB Asset Management for institutional investors

3.RMB Retirement Solutions, which handles retirement plans for

employers

Charles Schwab acts as a custodian for RMB accounts. A subsidiary, RMB

Funds, manages six mutual funds.