What Is a Crossover Fund?
- A crossover fund is a type of mutual fund that invests in both publicly-traded and privately-held companies.
- Crossover funds are constructed to offer investors the possibility of a higher return, but that also brings higher risk.
- Because of the riskier nature of the funds, they are better choices for investors with long-term horizons, rather than those closer to retirement.
Understanding a Crossover Fund
A crossover fund offers mutual fund investors potentially higher returns. While most mutual funds are designed to offer steadier returns over time, a crossover fund is designed to be high yield and high growth. However, crossover funds are higher risk.
Due to the high risk, this type of fund is not recommended for certain investors, especially those nearing retirement age. Crossover funds are considered to be a better long-term investment than a short-term one. Investors in crossover funds should be prepared to accept a good deal of volatility.
Private Equity vs. Public Equity Investments
Most mutual funds hold public equity investments. Public equity refers to companies that are publicly traded on a stock exchange such as the New York Stock Exchange or Nasdaq. Publicly traded companies have a few advantages for investors. Investors in public equity can gain access to the equity risk premium return driver. In addition, publicly traded companies are regulated by the Securities and Exchange Commission, and are required to disclose certain information to everyone at the same time.
Private equity refers to companies that are privately held and do not trade on public exchanges. This makes it difficult for individual investors to gain access to privately held companies.
Private equity investment primarily comes from institutional investors and accredited investors, who can dedicate substantial sums of money for extended periods of time. In many cases, considerably long holding periods are required for private equity investments. Ample time is needed to turn around a distressed company, or to enable liquidity events such as an initial public offering or a sale to a public company.
Crossover Fund Return Drivers
Crossover funds attempt to tap into the risk premium behind private equity, while also offering some of the liquidity of the public equities market. Equity risk premium refers to the excess return that investing in the stock market provides over a risk-free rate of return. This excess return compensates investors for taking on the relatively higher risk of equity investing. The size of the premium varies depending on the level of risk in a particular portfolio and also changes over time as market risk fluctuates. As a rule, high-risk investments are compensated with a higher premium.
While both public and private equity tap into the equity risk premium, private equity investors also expect to be compensated for other risks, including liquidity risk and manager risk.