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Course: Finance and capital markets > Unit 7
Lesson 4: Hedge fundsHedge funds, venture capital, and private equity
Similarities in compensation structure for hedge funds, venture capital firms, and private equity investors. Created by Sal Khan.
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- I just want to know how does Sal know this much about finance, science, and math?!(21 votes)
- He used to work for a hedge fund and he's got two degrees from MIT and a Harvard MBA. Most of the stuff he teaches here is slightly above highschool level, so even if he does not know something I'm sure it does not take him long to read up on it!(57 votes)
- Is it possible to track the long and short positions of any hedge fund?(2 votes)
- Every investment fund with assets over 100 million must file a 13F with the SEC each quarter. This form will report the long positions of the fund and are available to the public on the SEC's website.
Couple of drawbacks:
-Shorts and derivatives are not reported
-There is a 45 day delay between when the form is filed and when it is made public, so changes may have happened during that time
-A long being reported may actually be a hedge on a larger short position that is not reported.
-A fund could sell the position the day of reporting and buy it back the next day to avoid reporting.
For these reasons, the forms are really only of use for tracking longer term buy and hold fund managers. For anyone that employs a high turnover strategy, or a market neutral or arbitrage strategy, their 13F won't be of much use.(12 votes)
- How does a qualified investor research and "choose" a hedge fund (or vice versa, how do hedge funds find investors) if hedge funds can't market to the public?(5 votes)
- This question is particularly relevant now as new regulations are being proposed to make Hedge Funds more transparent as well as potentially enabling them to raise money more easily.
Major investors in Hedge Funds have typically included University Endowments, major pension funds, sovereign wealth funds, and large family offices (wealthy individuals). However, recent news has been increasingly covering funds that are taking a more active role with their own investments and divesting from their hedge fund positions owing to the exorbitant fees charged by the latter.(1 vote)
- What makes a company or hedge fund too big to fail?(1 vote)
- Mostly, it is a strong desire by a regulator or politician to protect rich people at the expense of taxpayers.
The argument is that if you owe me a lot of money, and I owe Sal a lot of money, and Sal owes Bill a lot of money, then if you don't pay, not only do I go broke but so do Sal and Bill and anyone who relies on them, and supposedly the macroeconomic consequences of this (for employment, essentially) are too dire to even take the chance.
Clearly a better solution would have been for me not to lend you so much, and for Sal not to lend me so much, and for Bill not to lend Sal so much, and then we wouldn't have that domino-effect problem.(6 votes)
- For the purposes of calculating fees and carried interest, how do hedge funds value assets that are not very liquid, e.g. a 50% ownership of a private company.(2 votes)
- They do a valuation math same as stock valuation of stock market listed shares. In the stock market, an individual stock may be priced over/under valued, but for private equity, it is always fair value.(1 vote)
- If an investor decides to return 10 percent of their stake in the hedge fund in turn for that percentage of the value, then does the fund then find a way to sell the 10 percent stake in their fund to another "sophisticated" investor?(1 vote)
Video transcript
One thing I probably
should make clear is that this idea of
getting a 2% management fee and then participating in
the profits at around 20%, getting this 20%
carried interest, this isn't unique
to hedge funds. This is actually the same
compensation structure that you'll normally
have at a venture capital fund or a private equity fund. And just to be clear,
venture capital really is a form
of private equity. But normally when someone
says private equity, they're not talking about
venture capital in particular. In all of these situations, the
managers will get roughly 2% for managing the fund and
they'll get 20% of the profits. The only difference really, in
terms of how it's structured, in a venture capital
or private equity fund will still have kind of
a limited partnership for the actual fund. And then they would have
a management company that gets the management
fees and the profits. The only difference is because
a hedge fund, for the most part, is probably going to invest
in public securities, it could get the money
right from the get-go and put that money to
work because it tends to invest in fairly
liquid assets. So this is fairly liquid
assets that they can just go out and buy. So a hedge fund will normally
just take as much money as it needs to invest
right from the beginning. A venture capital firm
or a private equity firm, what they'll do is
they'll say, look, I'm going to raise
$100 million fund, but I'm not going to be able to
just go out the door tomorrow and invest $100 million. In the case of a
venture capital firm, they're going to have to
look at business plans and entrepreneurs and
do their due diligence. Same thing for a
private equity firm. They're going to have to
look for companies that they might want to buy
private equity. You're normally talking
about more mature companies that maybe this firm thinks that
they can buy and turn around. Maybe more mature
companies that need some money to grow really fast. Venture capital
tends to be investing in some guys and a
business plan or maybe these smaller kind
of more, I guess we should call it,
more risky companies. But in either of
these situations, they won't just
find them tomorrow. So what they do is they
go to their investors and they get their investors
to commit a certain amount of money, to say
commit $100 million. And they'll get
the management fee on what those investors commit. But they won't take the
money right then and there. They'll take the
money as they need it. They'll do what's called a
capital call to their investors saying, hey, I just found a
good $5 million investment. I now need this percentage of
what you committed to so that I can go out and make the
investment in the hedge fund. That's not the case. All of it is up front. But it really is the
same compensation scheme. And that's why if you go to
any fancy business school, you'll find these are
kind of the careers that, at least the people
who are interested in-- I don't want to give them any kind
of characteristics-- there's a bunch of reasons why people
would want to go into these. But these are definitely
sought after careers at a lot of fancy
business schools.