Why are PE Funds much larger than Hedge Funds?
In terms of AUM, PE Funds tend to be larger than HF funds given the same number of FO investment professionals. I hear that PE is much more scale-able (though I always thought public equities would be more scale-able). Why is that so? Also, if the same # of employees can manage a much larger fund in PE than in HF, why is pay in PE not significantly more than HF on average (perhaps assuming rate of return and fee structure are similar) ?
Does it have to do with the expenses of doing PE... are some of my claims I made here incorrect?
Thanks!
In PE you're controlling businesses, which in many cases mean the PE fund owns virtually all of the equity. At say a vanilla L/S shop, you're not going to be doing this with public equity - you need to be relatively small enough in an issuer's float such that there aren't liquidity vacuums when you buy/sell. You can really get F'ed on liquidity even if you're fundamentally right about something. PE funds are also long-dated capital (5-10yrs), which allows your portfolio to be much more concentrated, so a $2bn vehicle can own something like 10-15 middle market businesses (~$100-200mm equity checks per business). HFs typically don't have long-dated capital (i.e. investors can call capital on short notice) so you need to run a much more diversified book (again, liquidity in your names is very important here) and manage your risk. A $2bn L/S book is fairly large and could have 100+ issuers in it. Depending on strategy (i.e. activist) you'll probably want to buy up sizeable positions in an issuer (but obviously not trigger a change of control) in order to influence the board to impose your agenda. I'd imagine the corresponding capital related to such a strategy would be a bit stickier.
PE is more scalable than HF. You can run the same LBO playbook and roll up a bunch of little guys in some obscure industry using debt and every $ you borrow accretes to the equity value (assuming you don't default). Not sure how you do this at a HF. Ideas can be very discrete and it's not like you can always time a cycle accurately. Would also argue that pay is not higher in most HFs than in PE. carry at a PE fund becomes powerful if your fund is successful. HF pay has much more annual volatility and there is some component of deferred or vested comp virtually everywhere.
Agree with this. PE has tremendous advantages of scale -- which is why the big PE firms have been so durable -- whereas for the most part hedge funds don't scale particularly well.
Outstanding response MidtownParkAve, seriously thank you for that.
BillyAckman Can you expand/elaborate on that? Do PE firms scale better because HFs have a harder time providing high % returns on larger amounts of capital? Or is it because of other reasons? Thanks.
Another thing that comes to mind is that PE firms can dabble in other areas like having credit arms, distressed and sometimes even doing public equity investing (i.e. Apollo).
Great answer! Thank u
Just curious, how do you guys go about modeling, if at all, for this? What's the analytical process to determine how the market will react to your fund taking on / off positions?
Look at daily average volume - you probably don't want to be doing more than 10% of daily volume. This isn't total position size rather what you trade in a given day. You typically don't buy a large position in one day. You move in and out of positions.
I'd be interested to hear from a senior guy on here, either in this post or if you were feeling generous enough to make your own post explaining this: but basically the economics of climbing the ranks of a PE firm, and how it the saying "if you're not first, you're last" kind of holds true in regards to rank. I was recently talking to a VP at a MM PE fund and though he has carry, he feels stuck at the fund, and knows he's too pussy to leave, but most likely not gonna move on up much within the firm. He described his situations as if he were the fourth string QB at Alabama. We looked at his firm's employee profiles, and there would be a whole lot of Principals, MD's, and finally Partners that he would have to either pass or catch up to if he wanted a more higher rank. He told me that if his firm were to literally double its AUM (which is rare and doesnt happen), they would just hire a couple extra associates and maybe one more VP, and perhaps (stretching it) one of the several highly qualified VP's would have to fight to the death to get the Principal promotion.
Basically he summarized to me and my buddy: "even if you lads are studs and are able to make it to the buy side, don't consider that a career, simply another step in your climb, that will most likely end with you doing something else entirely."
I'll take a stab at this since I have some personal experience, even though justice is probably done with its own post and I'm too lazy to start one. Basically, your VP friend is telling the truth and I have many friends even at the principal level of PE (both MM and megas) who feel trapped in their own org charts. Yes, they are getting a few pts of carry but not the lion's share that go to the founding/Managing Partners (~top 1-5 guys at the firm) with their giant houses in CT/Westchester/Hamptons and thus that middle tier of employees has to continue to grind and collect their paychecks. And PE is very much a grind - sourcing/evaluating inbound deals, managing all the consultants in diligence, lining up financing and all while hoping you don't underbid if there's an auction. Then there's a host of things you have to continue to do once the deal is booked.
The economic model is fairly simple - the guys who got in early are not incentivized to share their carry with each new employee that comes into the firm, especially when the firm is already an established success. If you're a start-up PE (or any business) you'd compensate employees who come in early with upside b/c the cash pay component (fees) may not all be there yet and also b/c high risk demands high returns, but if you're already established and do have the cash, why give the upside when you can just rotate people below you (intently or subtly by not promoting)? This speaks to the economic scalability of the PE model as well.
I think you can still have a career in finance but as the investment mgmt industry continues to mature and fill pockets of opportunity, it'll be harder to make a windfall, but this is true in most industries. Assuming there's no new innovation to the sector, maybe decades from now, working in high finance will just be like working a normal job where the pay isn't going to make you rich but provide you with a respectable living. But who knows, maybe there'll be a new vertical of finance that none of us know about yet that'll be like LBOs in the 80s or ABSs of the 2000s that'd perpetuate the racket we all work in.
Consider this in addition to what's already been said: the kinds of aggressive trades that hedge funds can do, if executed with the amount of capital used in a PE mega fund, would often be enough to trigger a market reaction.....and I also can garuantee that he HFTCs would clip your position nicely on the inbound. Hell even a large volume day trader (think starting with orders in the 500k area) has to be careful about placing orders that are large enough that someone(or computer) on the other side notices and starts trading against you.
Lots of good responses on the scale issue but no one addressing the comp question...so I'll give my two cents.
If you're an Associate/VP/Principal at a PE shop you're really just processing the transaction. There are so many checks and balances involved. For the most part you're not sourcing deals, making the investment decision, etc. It is very process driven with the investment committee eventually making the final say. PE firms need the investment professionals to be excellent executers. For this you're compensated well...but its really just the partners that are making the serious money as they are the true decision makers.
Conversely, at a HF an Analyst / Sr Analyst / VP (insert whatever title as HFs are different) sources his/her own ideas, largely operates independently and is the sole point person underwriting an investment thesis. The PM obviously has the final say of what gets in the book or not but its based on the recommendation of the Analyst - the PM can/will have questions and things to address but its largely the Analysts investment. Thus Analysts to a much larger extent have their own P&L. This attribution and control over an investment is why HF pay is higher than PE pay for non partner level people.
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