Equity Investment Examples: Understanding Your Portfolio Better

Equity investment is a financial transaction where shares of a company are bought, making the owner eligible for compensation based on their ownership percentage. The most basic equity investment is the purchase of a common share, which entitles the owner to a portion of the profits and assets. There are other types of equity investments, such as preferred shares, stock options, and convertible bonds, which differ from common shares in that they limit the owner's participation in the company's profits or require certain events to occur before they can be converted into equity instruments. Examples of equity investments include equity mutual funds, shares, private equity investments, retained earnings, and preferred shares.

Mutual funds and ETFs

Mutual funds are investment funds that pool money from multiple investors to purchase a diverse range of assets, such as stocks, bonds, or other securities. These funds are typically actively managed by professional fund managers, who aim to beat the market's performance. Mutual funds are traded only once daily after the market closes, and the price is based on the fund's net asset value (NAV). Mutual funds often have higher expense ratios, especially actively managed funds, and may charge additional fees such as early withdrawal penalties. They also usually require a minimum initial investment.

ETFs, on the other hand, are traded on stock exchanges throughout the day, allowing for real-time pricing. They typically have lower expense ratios due to passive management and operational efficiencies. ETFs do not incur front-end or back-end load fees. Most ETFs are passively managed, tracking a specific index to mirror its performance. There is no minimum investment beyond the price of one share, making them accessible to a broader range of investors.

ETFs are often considered more tax-efficient than mutual funds. They are structured to allow for in-kind creation and redemption processes, minimising capital gains distributions to shareholders. Mutual funds, on the other hand, tend to have higher tax implications as buying or selling by the fund manager can trigger capital gains, which are passed on to investors.

Both mutual funds and ETFs provide investors with a diversified portfolio and exposure to various asset classes. The choice between the two depends on factors such as investment style, desired level of active management, and tax considerations.

Common shares

When an investor buys common shares, they become a shareholder in the company. The number of shares they own determines their voting power. Shareholders receive profits from the company in proportion to their shareholding. For example, if a company declares a dividend of $10 per share, an investor with 100 shares will receive $1000.

In addition to common shares, there are other types of equity investments, such as preferred shares, stock options, and convertible bonds, which differ in the level of ownership and participation in the company's profits.

Preferred shares

It's important to note that preferred shares may be cumulative or non-cumulative. Cumulative preferred shares require the company to make up for any missed dividend payments, while non-cumulative preferred shares do not. Additionally, companies can issue multiple series of preferred shares, each with different economic rights, such as the size of the dividend and the order of preference for payments.

Retained earnings

Upon the issuance of dividends, a company retains some of the dividend payouts for future investments. This is an example of retained earnings.

Private equity investments

Private equity funds may acquire private or public companies in their entirety, or they may invest in buyouts as part of a consortium. They typically do not hold stakes in companies listed on a stock exchange.

Private equity funds are often grouped with venture capital and hedge funds as alternative investments. Investors in this asset class are usually required to commit significant capital for years, which is why access to such investments is limited to institutions and individuals with a high net worth.

Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for these acquisitions comes from outside investors in the private equity funds, usually supplemented by debt.

Private equity funds have a finite term of 10 to 12 years, and the money invested in them is typically tied up for the duration. The funds usually start to distribute profits to investors after a few years.

There are several types of private equity investments:

• Minority investments in startups: Funds typically invest in many businesses with unproven business models that may not yet generate revenue or profits. A small number of major successes make up for high failure rates.
• Minority investments in more mature companies: These companies are less established and faster-growing than a typical buyout target. They need capital to grow, commercialize, or professionalize.
• Majority investments in mature companies: Private equity funds traditionally make majority investments in mature companies and restructure their finances, governance, or operations to maximize returns for fund investors.

Private equity funds are one of the most common ways to gain exposure to private companies. Limited partners pool their money to invest in the fund, and the general partner manages it.

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