Table of Contents
- 1 What are Equity Investments?
- 2 Types of Equity Investments
- 3 Advantages of Equity Investments
- 4 Disadvantages of Equity Investments
What are Equity Investments?
Equity investments are nothing but buying into the stocks and shares of companies. Retail, as well as institutional investors, invest into equity for a number of reasons. The most common among them is to harness the sharp price rise in a short period of time categorizing such investments. Equity represents the own funds of the company. Therefore, the investor becomes a direct party to all profits and losses of the company proportionately. Another reason, why equity investments are so popular, is because of the magnitude of return it provides. The next best alternative an investor has is to count on the interest generated by the savings account or invest into bonds and similar instruments. These are a highly passive form of investments. It is almost impossible to accumulate wealth with such options.
In such a scenario, equity investments provide the necessary aggression required to fast-track the process of income generation. The icing on the cake is also the fact that equity investments can be tailored to suit the risk appetite of investors individually.
Types of Equity Investments
Investors can park their funds into one or more stocks depending on their preference. This form of equity investment can be ventured into independently and complete control over own funds is retained. No involvement from any fund managers or analysts is required. The trade can be executed by the investor himself. The decision regarding the stocks to pick may be at the investor’s own discretion. Alternatively, guidance can also be sought from various sources such as trade shows and expert recommendations.
Equity funds are a variation of mutual funds whereby the majority of the funds are invested into stocks and shares of companies. These funds are basically a pool of several equity stocks. They are aggregated and units of the fund are then sold to the investors. Consequently, an investor is able to enjoy the benefits of diversification and cover a wider base of equity investments. This would not be possible in an individual capacity by the investor. An equity fund can further be classified into numerous branches. Some of them are elaborated here below
Active & Passive Funds
Passive funds seek to replicate the index while active funds are very aggressive. The fund manager has to actively keep on altering the contents of the portfolio to ensure a return higher than the benchmark.
Growth, Income & Hybrid Funds
Growth funds invest into stocks with high capital appreciation potential. Income funds generally invest into large cap companies which are relatively stable and pay dividends on a regular basis. However, investors who prefer the best of both worlds can also opt for a hybrid fund. The fund managers here strive to provide reasonable appreciation while maintaining a constant stream of income.
These equity funds segregate their holdings on the basis of sectors. However, the market cap is carefully accounted for. They generally hold a couple of large-cap stocks as their core holding. This provides a firm footing to the fund. The balance is invested into small to mid-cap stocks promising attractive prospects. Therefore the volatility of the latter is offset by the stability of former.
Private Equity Investments
They represent investing in stocks of companies not listed on the exchange. They are generally not liquid and involve a huge ticket size. For this reason, only high net worth individuals and institutional investors can afford to invest in them. Private equity investments are resorted to at the inception or expansionary phase of a venture and entail high return on investment. A snapshot of popular private equity investment means is given below
The investors step in at the cradle stage of the company. These private equity investors charge a hefty premium and take away a considerable portion of ownership. They expect to be compensated handsomely for the risk they take with such baby companies. The risk involved is so huge that company may skyrocket or even never take off.
Growth capital is similar to venture capital funds except that they invest in mature companies. They provide funds to established companies seeking expansion, diversification and exploring new avenues. They come to rescue when the company is not in a position to raise more debt.
Real Estate Funds
These are private equity funds with real estate and properties as the main underlying. They are involved in acquisition, development, and maintenance of real assets. Rental income constitutes the mainstream of cash flow. The property is also sold away at opportune times to take the advantage of a bullish property market. The main advantage of this fund is that it enables small investors to reap the benefits of changes in property prices without actually buying one.
Advantages of Equity Investments
The equity investments can be diversified across various sectors, cap, geographies and even the phase of business cycles. The investor is thus protected against the consequences of “putting all eggs in one basket”. Turbulence in any specific stocks or sectors is unable to adversely impact the value of the portfolio as a whole.
A wide arena of mutual and equity funds have emerged lately. The sheer abundance of these funds enables the investor to choose a fund which exactly caters to his investment preferences. There is something for everyone in today’s market. Conservative to aggressive equity investment funds are available rampantly. Equity investments were earlier synonymous with risk and uncertainty. With the advent of portfolio funds that is no longer the case. Funds offset risky equity investments with cash and bond positions to offer a relatively secure product to the investor.
Though not always true for private equity investments, liquidity is a sure shot benefit for listed and public stocks. There is a ready market available for shares of listed companies. The volume and number of transactions are always large enough to assure the investor of a ready sell whenever he intends to. Cashing out and squaring position at any time is possible. Therefore, equity investments serve as a lucrative means of investment for investors with a not so long horizon.
Disadvantages of Equity Investments
The prices of equity investments are determined by the forces of demand and supply. The perception of investors also plays a key role. A negative sentiment or false information about a stock can spread like wildfire. This inadvertently impacts its prices. Investor perception is a highly random variable which cannot be controlled. Moreover, the companies operate in an ecosystem and are subject to business cycles, adverse government policies, and sector-specific disturbances. Equity investments display movement than its counterpart index or bonds. Risk-averse investors may, therefore, be uncomfortable parking their funds into such investments.
The investors do not have direct control over the equity funds they invest in. It is run by a fund manager who makes allocations into various stocks on their behalf. It will not be wrong to say that the investors are left at the mercy of the wisdom of their fund manager. Most managers are accustomed to a particular type of investing and follow similar patterns. Also, to an extent, the allocations are influenced by the manager’s personal preferences and beliefs. The investors have no option but to rely on their manager. Therefore, one must invest in more than one equity fund to do away with the impact of manager biases.
While diversification helps in eliminating unsystematic risks, there also exists the possibility of over-diversification. Where on one hand diversification helps in capping the downside, over-diversification may also limit one’s upside. A fund which may be diversified to an extent that it no longer reaps additional returns but only averages out the results. In such cases, the investor ends up merely replicating the index. An efficient diversification strategy is one in which stocks are carefully handpicked to harness its growth potential. Blindly adding stocks to the basket defeats the purpose.Last updated on : June 28th, 2018