Special Investment Funds: What Are They?

A special investment fund is a fund that is established for a specific purpose or event. For example, a government may establish a special revenue fund to collect money for a specific project, providing transparency to taxpayers about how their money is being spent. Special investment funds can also be established by companies to isolate financial risk or undertake risky ventures with reduced negative financial impact on the parent company and its investors. Special situations, such as mergers, acquisitions, or distressed securities, can also be a reason for a special investment fund. These funds are often event-driven or opportunistic and seek to profit from anticipated rises or recoveries in stock prices. One example of a special investment fund is the Special Opportunities Fund, Inc., which employs an opportunistic investment philosophy with an emphasis on investing in discounted closed-end funds and undervalued operating companies.

Characteristics of a Special Investment Fund (SIF)

Special revenue funds are established by governments for specific projects

Special revenue funds are established by governments to collect money for a specific project. They are set up to provide an extra level of accountability and transparency to taxpayers, ensuring that their tax dollars are used for the intended purpose. These funds are typically established for smaller-scale projects such as parks, libraries, beaches, and town plazas.

Special revenue funds are just one of the four basic buckets of budget money allocated by municipalities, the others being the general fund, the capital fund, and the "rainy day" fund. The general fund is used for usual and ongoing town expenses, while the capital fund is for large projects. The "rainy day" fund is for emergency expenditures.

The Government Accounting Standards Board (GASB) issued Statement No. 54 in 2011 to define special revenue funds and provide clarity on their usage. According to GASB, "Special revenue funds are used to account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for specified purposes other than debt service or capital projects."

Special revenue funds are further categorized into different types, such as revolving funds, receipts reserved for appropriation, school grants, and other special revenue funds. These funds are essential for maintaining financial compliance and ensuring that taxpayer money is used efficiently and effectively for the intended projects.

Specialised investment funds (SIFs) are lightly regulated and tax-efficient

Specialised investment funds (SIFs) are a type of investment fund established in Luxembourg that is lightly regulated and tax-efficient. The SIF regime is governed by Luxembourg law, which was established in 2007 and replaced a 1991 law that defined the legal framework for institutional funds. The 2007 law expanded the distribution scope to "well-informed investors".

The SIF law simplified the rules for setting up investment fund structures, from straightforward investment strategies investing in listed securities to hedge funds, real estate, and private equity funds. Due to their broad definition, most SIFs are qualified as SIF Alternative Investment Funds (SIF AIFs).

SIFs may be structured as common contractual funds (FCP), which have no legal personality and must be managed by a management company, or as investment companies with variable or fixed capital (SICAV or SICAF, respectively), which can be self-managed or managed by an external company.

The Luxembourg regulator (CSSF) issued guidelines for SIF vehicles, including a restriction on investing more than 30% of its assets or commitments in securities of the same type issued by the same issuer. There are no specified investment restrictions or leverage rules by the SIF Law; it simply states that a SIF should apply the principle of risk diversification.

Special opportunities funds are registered investment companies with a total return objective

Special opportunities funds, also known as "event-driven" or "opportunistic" funds, seek to exploit unusual events or special situations that compel investors to buy a stock or asset expecting a price rise. These events can include spinoffs, mergers, acquisitions, bankruptcy, litigation, shareholder activism, and more. For example, a large company spinning off one of its business units might create a special situation where investors buy shares in the larger company before the spinoff, anticipating a quick price increase.

The investment strategy of special opportunities funds focuses on identifying and investing in underappreciated or distressed assets that are correspondingly cheap. This strategy carries a higher level of risk due to the unpredictable nature of special situations.

Overall, special opportunities funds provide investors with the opportunity to capitalize on unique market events and situations by investing in a diversified range of assets, including stocks, bonds, and other securities.

Special purpose vehicles (SPVs) isolate financial risk and protect parent companies

Special Purpose Vehicles (SPVs) are separate legal entities created by a parent company to isolate financial risk and protect themselves from bankruptcy. SPVs are also known as Special Purpose Entities (SPEs) or bankruptcy-remote entities. They are formed as a separate company with their own balance sheet, assets, liabilities, and legal status. This structure allows the parent company to undertake risky ventures while limiting any negative financial impact on itself and its investors.

The operations of an SPV are restricted to the acquisition and financing of specific assets. They are often used in structured finance applications such as asset securitisation, joint ventures, or property deals. SPVs can also be used to raise capital by issuing bonds at more favourable borrowing rates than the parent company.

SPVs provide protection for a parent company's assets and liabilities, as well as protection against bankruptcy and insolvency. They also have more operational freedom due to reduced regulatory burdens. However, SPVs can be misused to hide company debt and financial losses, as seen in the Enron scandal. Therefore, investors must carefully analyse the financials of both the parent company and the SPV before making investment decisions.

In summary, Special Purpose Vehicles (SPVs) are valuable tools for parent companies to isolate financial risk and protect themselves from bankruptcy. They offer operational flexibility and facilitate capital raising. However, their potential for misuse underscores the importance of thorough due diligence by investors.

Special situations are atypical events that can alter a company's future course

A special investment fund is a fund that seeks to take advantage of atypical events that can alter a company's future course. These events are known as "special situations" and can be either positive or negative in nature. For example, a positive event could be a merger or acquisition, while a negative event could be a government antitrust inquiry. These events are often one-time occurrences that have a significant impact on a company's short-term prospects and stock price.

Special situations can arise from various triggers, such as breaking news stories, rumours, spinoffs, tender offers, mergers, acquisitions, bankruptcy, litigation, capital structure dislocations, shareholder activism, or stock buybacks. They can occur in any industry and at any point in an economic cycle.

Investors who focus on special situations aim to profit from the potential rise in valuation that these events present. This strategy is often considered risky due to its speculative nature, as it deviates from the underlying fundamentals typically used to select investments.

One notable example of a special investment fund is the Special Opportunities Fund, Inc., which employs an opportunistic investment philosophy. The fund focuses on investing in discounted closed-end funds, undervalued operating companies, and other attractive special situations, including risk arbitrage and distressed securities.

In addition, there are specialized investment funds (SIFs) in Luxembourg that offer a lightly regulated and tax-efficient regulatory regime for eligible investors. These funds can be structured in various ways and have a broad scope of eligible assets, providing flexibility for investors.

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