Hedge Funds and Private Equity Investments have a few similarities but have different end-goals.
They are similar in that they:
- Typically appeal to high-net-worth individuals due to the high cost of entry.
- Are often structured as limited partnerships.
- Both pay managing partners in a similar fashion: with management fees as well as a percentage of the profits earned.
One other key similarity between the two is that the accounting of both types of investments require specialized experts who are trained and knowledgeable about the nuances involved in these complex investment platforms.
This article will explain the differences between hedge funds and private equity funds as well as the accounting requirements necessary for reporting on these investments.
First, let’s dive a little further into the definitions – and the differences between – hedge funds and private equity funds.
Hedge funds are actively managed alternative investments that use pooled money and an assortment of strategies to earn returns for their investors.
The goal of a hedge fund is to get the highest investment returns possible as quickly as possible and they are focused on short-term profits. Hedge Funds are not regulated by the SEC. These types of funds are viewed as riskier than others for a few reasons:
- They require a significant minimum investment or net worth to participate in the fund.
- They employ risky investment strategies and often rely on borrowed money.
- They expect high returns in a short period of time.
Private Equity Funds
Private equity funds are the funds used by investors to invest directly in companies. They might purchase a private company but are equally as likely to purchase stock shares of publicly traded companies. These funds are focused on long-term earning potential.
Unlike hedge funds who are only required to make a one-time investment, those who invest in private equity funds are required to invest their capital whenever called upon to do so.
Even still, private equity investments are seen as less risky than hedge funds because of their focus on long-term viability and returns. They typically seek to purchase a controlling interest in a company, and then bring on new management or provide guidance to the existing management team of that company. Their aim is to improve profitability with the ultimate goal of selling the company after their improvements have been implemented, and the increase in profits has been realized.
Hedge Fund Accounting
The accounting related to hedge funds requires the compilation of all brokerage statements that reflect on the fund. Every investment must be accounted for and included.
In addition, hedge fund accounting will help to determine the break periods. Or, in other words, the accounting helps to regulate the timing of when earnings made by the fund will be paid out to the principles and partners of the fund.
Perhaps the most important report issued by a hedge fund accountant is the NAV, or the net asset value report. This report is required once a year, and it is used to demonstrate the hedge fund performance record. It is this use that makes it such an important deliverable: it is based on these results that many investors decide where to invest. In addition, hedge fund accountants must also provide the annual income tax reports to the investors of the fund.
Private Equity Accounting
Private equity funds must follow the standards set forth by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). However, the operations and financial situation of the private equity fund might – and most likely will – require modifications to the accounting format of these standards. This is because these original standards were not created with private equity funds in mind.
Another important aspect to private equity accounting is an understanding of and reporting about the amount of control the fund has over an entity.
And of course, the accounting standards used by the private equity will have an impact on how and what is reported. The US GAAP (generally accepted accounting principles) differs from the UK GAAP, and both can be different from the IFRS (international financial reporting standards).
Plumb Family Office Accounting & Bill Pay has decades of experience working with both hedge fund and private equity investors. We understand the refinement, complexity, and intricacy involved in the accounting required for both investments. If you are a hedge fund or private equity investor – or a financial advisor to a client who is – please let us know if we can help.