Comprehensive Guide to the Fund Industry in Portugal

Legal Framework for Funds 

In Portugal, the management of assets is governed by the regulatory framework set out in Decree-Law 27/2003, dated April 8, 2023. This legislation delineates the responsibilities involved in managing and administering a portfolio of assets, particularly highlighting the role of collective asset management in fueling the economy through investment funds.

Collective asset management in Portugal operates through various structures, depending on their purpose and nature. Central to this system are the Collective Investment Undertakings (CIUs), institutions designed for the collective investment of capital raised from investors, aligning with a predefined investment policy.

Classification and Regulation of Collective Investment Undertakings in Portugal

CIUs are categorized into:

• Undertakings for Collective Investment in Transferable Securities (UCITS, or OICVM in Portuguese);
• Alternative Investment Funds (AIFs), with three main types based on the principal investment object and a residual, open category. Notably, real estate AIFs, venture capital AIFs, and credit AIFs, a recent addition, are crucial components of the Portuguese market.

These CIUs adhere to the European Union's regulatory framework, with UCITS regulated by Directive 2009/65/EC and AIFs by Directive 2011/61/EU. AIFs encompass a broad range of funds, including venture capital and private equity funds, real estate funds, hedge funds, and funds of funds.

Supervision and Reporting

In Portugal, the regulation of Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) is governed by a stringent framework, ensuring their operations adhere to the highest standards of transparency and compliance. These funds are under the vigilant supervision of the Comissão do Mercado de Valores Mobiliários (CMVM), the Portuguese securities market commission, which mandates regular reporting to uphold investor trust and regulatory integrity.

Crucial to maintaining the financial health and integrity of UCITS and AIFs, independent audit firms are required to audit these funds. This external verification safeguards the accuracy of financial reporting, bolstering investor confidence. Additionally, UCITS and AIFs must appoint a depositary bank to hold the funds' units ('unidades de participação'), further securing the assets against potential risks.

Portugal's alignment with the European Union's financial regulatory standards is evident in this robust oversight mechanism. Through close cooperation with the European Securities and Markets Authority (ESMA), Portugal ensures its regulatory practices for investment funds are harmonized with EU-wide regulations, providing a secure and transparent investment environment. This adherence to European standards reaffirms Portugal's commitment to maintaining a reliable and investor-friendly financial market.

Simplifying Investment Fund Terminology

To demystify the terminology for our audience, our website introduces a simplified nomenclature:

• Mutual Fund: Corresponds to UCITS or OICVM under Portuguese legislation. Accessible to retail investors, these funds feature lower investment minimums, daily pricing, high liquidity (with the possibility of redemption at any time - subject to potential early notice requirements), and invest in publicly listed companies. Their investment focus can include equity, debt, or a combination of both.
• Private Equity Fund: Corresponds to AIF or OIA under Portuguese legislation. Primarily targeted at professional investors, these funds are known for higher investment thresholds, closed-end structures, and long maturities (usually ranging from 5 to 10 years), focusing on investments in private (unlisted) companies. Investment types can vary across equity, debt, or a blend of both.
• Venture Capital Fund: A specialized segment of Private Equity that targets early-stage companies (startups), providing capital to support their initial development and growth. 

This classification not only simplifies understanding for non-expert readers but also aligns with the regulatory landscape in Portugal, ensuring investors can make informed decisions when navigating the Golden Visa's investment options.

Fund Structures: Open-End vs. Closed-End

Investors in Portugal can choose between:

• Open-End Funds: Offering flexibility, these funds allow for the continuous issuance, resale, or redemption of their units, accommodating varying investor needs over time.

• Closed-End Funds: These have a set number of units, making them more exclusive and requiring investors to trade existing units on the market to adjust their investment positions.

The chart below shows the distribution of total investment for open and closed funds (in millions of euros) in Portugal since 2014, according to information from the BdP - the Central Bank of Portugal.

You can find additional information on the structure and governance of these investment entities, on the official guide by the Bank of Portugal here.

Main Investment Instruments used by Funds

Funds can adopt specialized investment strategies:

• Equity Funds: Targeting mainly equity investments, these funds invest in both listed and unlisted stocks, along with units from other equity-focused funds.

• Debt Funds: These funds concentrate on fixed-income assets, with a focus on medium to long-term bonds, and are suitable for investors seeking steady income streams.

• Mixed Funds: Offering a blend of fixed-income (debt securities) and variable-income (equity) investments, mixed funds provide a balanced approach to market engagement.

Income Distribution Strategies 

Funds offer flexibility in terms of income distribution, catering to the varied preferences of investors. Depending on their investment strategy and portfolio composition, funds may opt for one of two approaches regarding the handling of generated income:

• Accumulative Approach: This strategy involves retaining any income or gains generated by the fund and reinvesting them to compound growth over time. Funds that adopt this approach aim to increase the value of the fund's units, making it an attractive option for investors seeking long-term capital appreciation.
• Periodic Distribution: Some funds choose to distribute income periodically to their investors. This approach is often associated with funds that have debt instruments, like bonds, in their portfolio, offering investors a regular income stream. This can appeal to those who rely on their investments for consistent earnings.

In the context of private equity funds, returns are typically realized when the fund exits an investment by selling its stake in a company at a profit. At this point, the fund can decide whether to distribute these returns to investors or retain them within the fund until maturity.

This flexibility allows investors to select funds that align with their income needs and investment goals, whether they prioritize regular income or long-term growth.

Risk & Return

Understanding the risk and return dynamics across different investment vehicles is crucial for crafting a balanced portfolio. This section delves into the comparative analysis of investment funds, private equity, and venture capital, shedding light on their inherent risk profiles and expected returns.

• Mutual Funds: Investment funds that allocate capital to public equities are generally riskier than those focusing on debt instruments. The volatility inherent in the stock market contributes to this increased risk. However, the public nature of these investments allows for early redemptions, providing liquidity and flexibility to investors. Additionally, the performance of these funds can be easily tracked against benchmarks, such as market indexes, offering transparency. Typically, investment funds aim for annual returns ranging from 3% to 10%, depending on the market conditions and the fund's investment strategy.
• Private Equity: Private equity funds, which invest in non-listed companies, cater to seasoned investors seeking to capitalize on companies with significant growth potential. These closed-end funds aim to enhance value through strategic initiatives such as operational improvements, market expansion, mergers and acquisitions, or diversification into adjacent product lines. Given the hands-on approach to driving company growth, private equity investments carry a higher risk but offer the potential for substantial rewards, with targeted annual returns between 10% and 20%.
• Venture Capital: Venture capital represents the highest risk category among these investment types, focusing on startups and early-stage companies with explosive growth potential. The speculative nature of investing in unproven business models and markets means that while some ventures may succeed spectacularly, others may fail entirely. Despite the high risk, the allure of venture capital comes from the potential for outsized returns, typically aiming for returns well above 15%.

Each investment type presents a unique risk-return profile, catering to different investor appetites and portfolio strategies. While investment funds offer a blend of risk and liquidity with moderate returns, private equity and venture capital target higher returns by engaging more directly in the growth trajectory of underlying companies, albeit at increased risk levels. Investors must weigh these factors carefully, considering their own risk tolerance, investment horizon, and financial goals when selecting the appropriate vehicle for their capital.

Investment Strategies in Private Equity Funds

Private Equity (PE) firms employ diverse strategies to optimize returns on investments. These strategies are tailored to the specific growth stage, industry, and operational needs of the companies in which they invest. Below are some of the primary strategies and types of funds commonly found within the PE landscape, those frequently encountered in Portugal for Golden Visa purposes:

• Buyout Funds: Buyout funds are a cornerstone of the private equity industry. These funds specialize in acquiring majority or full control of companies, often focusing on businesses facing succession challenges or disputes among shareholders. A key tactic involves retaining parts of the existing management team, leveraging their industry expertise and operational knowledge for quicker turnarounds and enhanced company performance. The end goal is typically to streamline operations, boost profitability, and eventually sell the company at a profit, either through a public offering or to another private buyer.
• Growth Funds: Growth funds target companies that exhibit potential for significant expansion but do not require a full change in ownership. Instead of taking full control, growth funds usually acquire a significant minority stake and often place a strategic manager, such as a CFO, on the board. This approach allows the fund to influence the company's strategic direction and financial management without disrupting the day-to-day operations, supporting expansion efforts like market penetration, product development, or geographical expansion.
• Venture Capital: As a subset of private equity, venture capital (VC) funds focus on early-stage companies with high growth potential. VC funds invest in startups and scale-ups, offering not just capital but also strategic advice, industry connections, and operational expertise. The risks are high, given the unproven business models of their investees, but so are the potential returns for successful ventures.

Each of these strategies represents a different approach to creating value within the spectrum of private equity investing. PE firms may specialize in one particular strategy or manage a portfolio of funds each dedicated to different strategies, offering investors a range of options to align with their risk tolerance, investment horizon, and expected returns.