Private equity versus hedge funds

Private equity and hedge funds are the two hottest investment vehicles. When the management company goes public, which of these is more attractive? FT's Lex column believes that private equity has the edge mainly because of their longer time horizons.

First, assets (in private equity) are tied up long-term. Kohlberg Kravis Roberts, which plans an initial public offering, says 73 per cent of its assets are committed for as much as 18 years. While KKR is highly unlikely to hold any investment for that long, it does give huge flexibility to ride out tough times. And it provides a steady stream of cash from the 2 per cent management fee – alongside the bigger and more volatile 20 per cent share of investment gains. Private equity funds also juice fees with a charge for each deal they do and sometimes a cut for syndicating equity to third-party investors. That can take underlying management fees closer to 3 per cent.

By contrast, hedge fund investors can pull their money quickly if performance is bad, making the underlying fee stream less secure. In addition, poor investment returns can quickly inflict a double whammy on a hedge fund manager’s earnings – of weak performance fees and falling AUM as investors withdraw money.

Second, private equity firms feel more solid. They have established brands such as Blackstone and KKR, they buy full control of businesses people know, and buy-outs have largely avoided financial trouble in recent years. Hedge funds, for some, conjure up images of whizz-kids rolling the dice on behalf of clients, leading to high-profile blow-ups such as Amaranth and recently some mortgage funds at Bear Stearns.

Finally, private equity firms have a “cookie jar” of unrealised gains on their illiquid investments that should emerge as cash flow when the businesses are sold. (At least, that is the case in today’s strong market.)