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2011 Senior Seminar

2011 Senior Seminar. This Will Be Our Only Meeting without a Guest Speaker We need to cover the structure and terminology of Hedge Funds Private Equity Funds. Imagine overhearing the following comment:. “We charge a hundred and fifty bips with a fifteen carry,

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2011 Senior Seminar

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  1. 2011 Senior Seminar • This Will Be Our Only Meeting without a Guest Speaker • We need to cover the structure and terminology of • Hedge Funds • Private Equity Funds

  2. Imagine overhearing the following comment: “We charge a hundred and fifty bips with a fifteen carry, but we don’t use high water marks, but there is a clawback feature. So we are a lot better deal than the usual two and twenty. We benchmark with the average ten year yield over the investment period. We have only a two year lockup, but we gate if our drawdowns exceed ten percent. That holds the limiteds to a max twenty percent withdrawal. The gp is twenty percent of the total and there are no fund of funds among the limiteds.” Who is saying this and what does it mean?

  3. Basis Points (bps, bips) • 100 basis points = one percent • If a manager charges 25 basis points and is managing $ 100 million then the fee per year is $ 250,000 per year. (That will go up and down with the value of what the manager is managing). • Index funds charge between 0 and 8 bps

  4. The “Carry” • “Carry” is short for “carried interest” • It is the “performance fee” • Best described by example. Suppose “carry” is 20 percent: • If the manager in previous slide produced a one year return of $ 30 million, they would be paid twenty percent of the $ 30 million, or $ 6 million.

  5. The “Carry” Can Create Some Strange Results • Imagine the manager produced $ 30 million in gains in year one and had $ 24 million in losses in year two: • Manager is paid a carry of $ 6 million in year one • Manager is paid a carry of zero in year two • Investor makes zero over two years.

  6. There is Another Fee Besides the “Carry” • The “Commitment Fee” on “committed” dollars invested • Suppose it is 200 basis points: • On $ 100 million, that would amount to $ 2 million annually • In addition to any “carry”

  7. “Two and Twenty” • Two means 200 bps commitment fee • Twenty means the carry is twenty percent • So, if a manager makes $ 30 million before fees for the investor, the fees will be • $ 2 million for the commitment fee • And twenty percent of the $ 28 net income or $ 5.6 million • Total fees $ 7.6 million, Investor gets $ 22.4 million net • Investor return is 30 percent gross, 22.4 percent net

  8. Example Suppose you “raise” a $ 100 million fund Management fee will be $ 2 million first year regardless of how well the fund performs Make 20 percent in first year (market might be up 30 percent) Performance fee with be 20 percent of $ 18 million, or $ 3.6 million Clients make 14.4 percent net of fees Net Fee Earned – 560 basis points (which means 5.6%) or $ 5.6 million

  9. Make $ 20 million gross first year Fee is $ 5.6 million in year one $ 114.4 million at end of year one Then lose $ 20 million Fee is $ 2.288 million in year two Start with $ 100 million $ 92.112 million left At end of year 2 Neither made nor lost money (gross), but fees amount to $ 7.888 million, so net loss of $ 7.888 million

  10. No gain or loss in two years $ 100 million $ 86.4 million Lose $ 50 million First year Make $ 50 million fee is $ 11.6 million for 2nd year Fee is $ 2 million for first year $ 48 million Total fees $ 13.6 million

  11. High Water Mark At year end (or quarter end depending on fund rules), performance fee is limited to 20 percent of (end of period value less previous highest end of period value)

  12. No gain or loss in two years Now, suppose there is a “high water mark” $ 100 million $ 96 million Lose $ 50 million First year Make $ 50 million fee is $ 2 million for 2nd year because no carry Fee is $ 2 million for first year $ 48 million Total fees $ 4 million

  13. Make $ 20 million gross first year In this example, high water mark makes no difference Fee is $ 5.6 million in year one $ 114.4 million at end of year one Then lose $ 20 million Fee is $ 2.288 million in year two Start with $ 100 million $ 92.112 million left At end of year 2 Neither made nor lost money (gross), but fees amount to $ 7.888 million, so net loss of $ 7.888 million

  14. High Water Mark Example Performance fee only on this difference High Water Mark No performance fee

  15. The “Clawback” • An arrangement that calls for a return of performance fees earned in prior periods if losses are sustained in a future period • Example: • If, in any period the fund loses any money, then the manager will be assessed 20 percent of the loss up to the amount of his accumulated carried interest over the life of the fund (minus any prior assessments) • The above is a particularly strong clawback….most are much less punitive to the manager.

  16. Private Equity Funds, Real Estate Funds and Hedge Funds All: • Have a “commitment fee” and a “carried interest” percentage • Most common is historically “2 and 20,” but in recent years the market has moved to “1 and 20” • Commitment fees are normally paid quarterly (every 3 months) • Carried interest fees are calculated on an annual basis • High water marks and clawbacks are becoming more common • All investors in a fund are treated the same with one exception (side by side investing in private equity)

  17. The Structure of Normal Asset Management • Mutual funds (like buying a stock if closed end); buying “unit” interests in an existing pool of assets if open end) • Charge between 50 and 250 basis points (most cluster around 150 basis points) • That is, ½ of one percent to 2 ½ percent of principal • No performance fees • Investment advisors (negotiable contract between investor and manager) • US Common Stock: 25 to 75 basis points • Fixed Income: 5 to 50 basis points • Performance fees – rare, but a growing phenomenon

  18. The Structure of a Typical Hedge Fund or Private Equity Fund • Limited Liability Company (which is essentially a “partnership,” where the members have limited (to their “committed” investment liability) • The LLC has • Managing Member (or General Partner)…called the “manager” • Limited Member (or Limited Partner)…called the “limiteds” • Investors are the “limiteds” • Manager manages the fund and collects the fees

  19. Hedge Funds • What Is a Hedge Fund? • Origins • Partnership Structure (now LLC structure…same thing) • Performance Fees • Strategies • 70 % L/S Equity • Various other strategies

  20. Long Short Equity Buy Stocks Also Sell (Short) Stocks Example: Buy $ 100 million worth of stocks “long” Sell $ 100 million worth of stocks “short” “market neutral” if stocks are similar

  21. Several Types of Long Short Equity Hedge Fund • Market Neutral • Long Bias (Own $ 100 million; short $ 30 million) 70 % long bias) • Short Bias • Can go either way • (“130/30” funds try to compete with hedge funds)

  22. Private Equity • Mostly invest in equities (private companies mostly) • Some invest in debt (some distressed, some mezzanine) • Biggest funds are “buyout” funds (LBO funds) • Smallest funds (tend to be “venture capital” funds • Most common are “middle market” funds • All have 7 to 10 year lockups • Difference between “committed funds” and “invested funds” • Capital calls/distributions

  23. The End

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