Hedge funds and Private Equity - PES

Based on Greenwich Associates findings, we can assume that hedge funds pay approximately
30 per cent of all equity trading commissions in the US. This, and similar information on the European
side, confirm our beliefs that hedge funds are important client groups for investment banks.
But the lack of disclosure by the banks makes it difficult to quantify. Based on accessible reports
and data estimates we can approximate the importance of hedge fund activities for the investment
banks – they derive about 15-20 percent of their revenues from hedge fund activities.
Similar, recent information confirms that investment banks are purchasing more hedge funds.
Information from 2006 confirms, for example, that Morgan Stanley increased its minority positions
and total acquisitions in hedge funds in 2006. There are several examples of this activity
confirming that banks through their investments in direct hedge fund industry are snapping up
managers of hedge funds to meet increasing demand for these types of investment.
Investment bank business with hedge funds is often first and foremost associated with prime
brokerage. But the interrelations are much more complex – linked to other sources of revenue
such as bid ask spreads from trading commissions etc. All in all, the tendency for the behaviour
of hedge funds and investment banks to become increasingly similar, raises the question of
regulation. When it comes to banks, the actual regulation and need for updating on a regular
basis is not questioned. The central argument is the externalities. Ordinary banks are regulated
to protect their depositors. The argument for regulating investment banks is to protect investors
in securities markets. And the central argument for regulation is, after all, that any serious
malfunction of the banking and securities market could create serious systematic consequences
for the real economy, for jobs, for investments, for growth.
If there is a case for systemic risks connected to the hedge fund industry – and there seems to
be, as we shall see later – it creates a further argument for claims of disclosure, transparency
and regulations – as in the case of commercial banks and investment banks.
1.6 The costs, the management fees – the effects
In the hedge fund industry, calculations of fees are based on two components: A 2% management
fee charged on an AUM basis plus a performance fee of 20%. The performance fee is
typically determined as a share of the attained absolute return in excess of a hurdle rate, often
subject to so-called “high-water marks” (i.e. performance fees are only paid if the value of AUM
is above a previous high).
The level of management fee on average is currently around 1.5% of AUM in the case of single
strategy products and reduced to 1% for FOHFs. As far as performance fees are concerned,
those paid on single strategy products are higher than for FOHFs: 25% on average in the former
and 10% in the latter.
According to a UBS top-down analysis:
The global aggregated amount of fees generated by the hedge fund industry in 2004 has
been in the region of $ 45 Bn.
90% ($ 41 bn) of the above amount rewarded single hedge fund managers and the last 10%
($ 4 bn) those of FOHFs.
As we can see, the fees are huge relative to other forms of asset management.
Part I – Hedge funds and private equity funds – how they work
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