Hedge funds and Private Equity - PES

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If we assume US mutual fund industry to be around $ 7.000 bn and the average management fee
to be 0.60%, the aggregate gross fee income would be (simplifying to the extreme) around
$ 42 bn. In other words, it is not entirely unthinkable that the global hedge funds industry is
generating more fees than the much larger US mutual fund industry.
But this is not the total picture.
Some studies estimate that hedge funds pay:
4-5 % of AUM to their managers (management fees plus performance)
Around 4 % of AuM to the investment banking industry
To maintain this pay-out and keep investors confident and satisfied, hedge funds need growth
returns of around 20 %!
This fee structure and the level is not a “law of nature”. Neither is it market based. It simply seems
to be a “characteristic” of the hedge fund industry and not questioned or challenged by anyone.
We think it highly questionable because the pressure of hedge funds to create such huge gross
returns is in itself having strong effects on the character and concrete content of hedge fund
strategies.
The impact of fees and transaction costs to hedge funds, investment banks, prime brokers and
trading counter parties is illustrated in a recent study (Dresdner/Kleinwort. Equity research.
February 2007). As seen from the two charts, the “net return to investors” on the right hand side
represents the HFR composite index return net of all fees. By adding the 2 % plus 20 % fee
structure, the “gross performance after execution costs” is reached. If we then add the execution
costs, we are having the “gross performance before execution costs”.
A recent paper from Dresdner Kleinwort illustrates this point 11 :
2006
2005
(%)
25
20
15
10
5
Hedge fund industry – from gross return to net return
22.5
0
Gross performance Execution cost Gross performance
before execution received by investment after execution cost
cost
banks
Source: Dresdner Kleinwort Equities research estimates
(%)
25
20
15
10
5
17.0
4.3
3.8
18.3 5.3
Fees paid to hedge
fund managers
11 Dresdner Kleinwort, “Credit Suisse, Deutsche Bank, UBS - How important are hedge funds for the investment banking industry?”, Equity
Research 6. February 2007, p.16.
13.1
0
Gross performance Execution cost Gross performance
before execution received by investment after execution cost
cost
banks
Source: Dresdner Kleinwort Equities research estimates
4.3
Fees paid to hedge
fund managers
13.0
Net performance
to investors
18.8
Net performance
to investors