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 in 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 in bonds and similar instruments. These are highly passive forms 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 also design to suit investors’ risk appetite individually.

Types of Equity Investments

Individual Stocks

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 investor can also execute the trade himself. The decision regarding the stocks to pick may be at the investor’s own discretion. Alternatively, they can also seek guidance from various sources such as trade shows and expert recommendations.

Equity Investments

Equity Funds

Equity funds are a variation of mutual funds whereby the majority of the fund’s investment is 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 as 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 portfolio contents to ensure a return higher than the benchmark.

Growth, Income & Hybrid Funds

Growth funds invest in stocks with high capital appreciation potential. Income funds generally invest in large-cap companies that are relatively stable and pay dividends regularly. 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.

Market Capitalization

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 investment is into small to mid-cap stocks promising attractive prospects. Therefore the volatility of the latter is offset by the former’s stability.

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 resort to a venture’s inception or expansionary phase and entail a high return on investment. A snapshot of popular private equity investment means is below:

Venture Capital

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 a handsome compensation for their risk with such baby companies. The risk involved is so huge that the company may skyrocket or even never take off.

Growth Capital

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 the 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 involve themselves in acquiring, developing, and maintaining real assets. Rental income constitutes the mainstream of cash flow. The property is also sold away at opportune times to take 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

Diversification

The equity investments can be diversified across various sectors, caps, 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.

Risk Adjusted

A wide arena of mutual and equity funds has emerged lately. The sheer abundance of these funds enables the investor to choose a fund that 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.

Liquidity

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

Volatility

The market forces of demand and supply determine the prices of equity investments. 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. A highly random variable that can’t be in control is investment perception.

Moreover, the companies operate in an ecosystem and are subject to business cycles, adverse government policies, and sector-specific disturbances. Equity investments display more movement than their counterpart index or bonds. Therefore, risk-averse investors may be uncomfortable parking their funds into such investments.

Manager Bias

The investors do not have direct control over the equity funds they invest in. The fund manager 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 manager’s personal preferences and beliefs influence the allocations. The investors have no option but to rely on their manager. Therefore, one must invest in more than one equity fund to avoid the impact of manager biases.

Over Diversification

While diversification helps eliminate unsystematic risks, there is also the possibility of over-diversification. While, on the one hand, diversification helps in capping the downside, over-diversification may also limit one’s upside. A fund that may be diversified to the 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 their growth potential. Blindly adding stocks to the basket defeats the purpose.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

1 thought on “Equity Investments”

  1. Hi Sanjay! Well written blog, congratulations !!!
    Do you reside in the USA or in India?
    Can you raise funding for a private firm?
    Are you also a commercial broker or an institutional broker?
    I have many other questions. Would you please, contact me for us to learn if we could conduct business. Thank you very much.
    Best regards, Manny De Angelo

    Reply

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