Private equity is a big topic these days, but a majority of investors might not be familiar with how these funds actually work. The term refers to a specific asset class that consists of a group of securities. Mutual funds and hedge funds invest in equity securities as well, but private equity funds are different in that they trade in securities that aren’t publicly listed on a stock exchange. Many of these equity funds also hold debt in companies that aren’t listed on any major exchange.

A brokerage firm that specializes in these specific types of securities usually starts these types of funds up. Venture capital firms and angel investors have also started up their share of private equity funds, but these are generally considered riskier investments than those managed by specialized private equity firms. Retail investors might want to consider a few things before they put their money into any of these funds.

Past Performance Doesn’t Predict the Future

The SEC has made sure to attach a warning about using past performance as an indicator on just about every investment, but this hasn’t ever stopped investors from doing just that. Any retail investor who wants to consider these funds would be better off looking at who runs them than what they might have done in the past.

It’s generally best to research large funds from big companies like Fortress Investment Group, which is known for its connection with top financial thinkers like Pete Briger. Most retail investors will want to avoid private equity funds that are managed by companies that are a bit negligent when it comes to listing their personnel.

Leveraged Buyout Profits

Investment managers often say that private equity funds are essentially a rebranding of the old leveraged buyout business plan. Leveraged buyouts are a major strategy that many of these funds use, and small retail investors should familiarize themselves with the concept before putting any money into a fund.

Private equity firms will often buy a majority of shares in an existing mature company. While private equity financing is often associated with venture capital, these buyouts provide a safety net if some of the new companies the fund is associated with go sour. People willing to put money into such funds might want to research the mature companies that the company bought into. Most investors will want to read up on all the exciting startups that private equity funds buy into, but looking at the leveraged firms is every bit as important.

Make sure that the companies that were involved in these transactions generate a positive cash flow. Mature companies that have started to bleed money will really start to drag the fund down over time.

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