Thursday, November 25, 2004

Kings of capital

The Economist has a nice survey on private equity funds (which include venture capital and traditional buyout funds). For those unfamiliar with the details, most funds have a "2 and 20" reward structure, taking a 2% management fee each year and 20% of profits. For example, a $1 billion fund, run by 5 partners, would split $20M per year in fees, and another $20M in "carry" assuming a 10% return on the fund. (Hedge funds work similarly.) No surprise that everyone in finance these days wants to be in private equity or at a hedge fund. Sadly for investors though, private equity and hedge funds often underperform indices like the SP500, even though they take on greater risk. Jon Moulton of Alchemy, a British private-equity firm, is puzzled: “A lot of people in the industry already make several million a year without having to perform. I can't understand why investors haven't put more pressure on fees.”

One interesting statistic is the divergence in performance by investor class: it seems that some limited partners (LPs, or investors) are much better than others at picking funds. University endowments have been particularly successful, while banks have performed dismally.

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