Private Equity 20 Lectures (16) What makes hedge funds so mysterious? What is the difference between

Private Equity 20 lectures, Silicon Valley investors must study the law, I am the United States attorney Liu Xiaoxiao.

When it comes to funds, the concept of "hedge fund" basically pops up in everyone's mind, so why are hedge funds so mysterious? So why are hedge funds so mysterious? What is the difference and connection between hedge funds and private equity funds? Today we will talk about hedge funds.

Let's take a look at the world's top 20 hedge funds, as you can see, basically in the United Kingdom or the United States of America, these two countries. Which I'm sure many of you have heard of, like Bridgewater Fund is the world's largest hedge fund, or there are two sigma, the two founders of this fund recently also appeared infighting, the reason is that the structure of their equity parity, you must go to see my video "equity parity entrepreneurship is bound to fail".

Let's start with why hedge funds are called Hedge Funds and where the name comes from.Hedge is a type of fenceHedge is meant to protect your fund and reduce your fund's risk. So would you say Fence is not a hedge? What is the difference between these two types of hedges? From the English semantics, Fence is often an artificial fence made of wood, while Hedge is in a row of trees to block, so you can think of Hedge is more like what we often say the meaning of the green belt or isolation zone.

So it should be said that the Hedge has a kind of protection through its own natural nature, which is very consistent with the nature of the Hedge Fund, because the Hedge Fund is through the allocation of two different directions of the investment underlying to use its natural nature to hedge the risk. For example, I bought a call on corn, but at the same time I was worried in case it was a bad year for sunshine and heavy rain, so I

I also bought a call on greens, because if there is a lot of rain, the greens will grow well even though the corn will not be harvested.

Fence is more deliberate and for the protection, there are more human factors in, so some time ago we talked about Biden through the executive order to limit the dollar fund investment in China's high-tech, Biden used the word "small yard with a high fence", the place of Fence is also the same as a small yard with a high fence, so it's a good idea to buy a bullish position on vegetables. The Fence in this case is also an indication of the external imposition of factors.

Having said that, you should have realized that hedge funds are called hedge because they are named after the allocation characteristics of their portfolios.

In fact, according to the broad definition of private equity funds, hedge funds are also a kind of private equity funds, because hedge funds are also not public offering, but only for a small number of qualified investors (Accredited Investors). From the narrow definition of private equity, hedge funds and private equity funds are parallel concepts. So let's compare hedge funds and private equity funds from several perspectives, in these comparisons, we are in accordance with the narrow concept of private equity funds.

1. Investment cycle

In the investment cycle, hedge funds pay attention to fast in and fast out, the lock-up period is usually only one or two years, while the ordinary private equity funds we have said that once invested in the ten years after the eight years can not be moved. Of course, hedge funds it is still a private equity, and then how fast in and out will not be like the public equity fund as today, click the mouse to buy, tomorrow, click the mouse to sell, just that the investment cycle of hedge funds is much shorter than the ordinary private equity funds.

2. Investment target

Because of the nature of hedge funds, hedge funds tend to invest in assets that can provide a good return on investment (ROI) in the short term, such as real estate, currencies, financial derivatives and even works of art, with the only requirement being high liquidity. It can be said that the investment targets of hedge funds can be said to be the broadest among all funds, in contrast, the investment targets of private equity funds are very narrow, and can only invest in the equity of unlisted companies. By the way, although cemetery funds can also be fast in and fast out, they can only invest in stocks or bonds of listed companies.

3. Industry type

It is because private equity funds do not seek short-term returns, but focus on long-term profits, so private equity funds are usually industry-based classification is very obvious, for example, some private equity funds say we are investing in the field of automated driving, some say that we are investing in biomedicine, some say we are investing in artificial intelligence, and private equity fund managers are usually to be very experienced in a particular field.

Ordinary private equity funds are also called "private equity funds", because the strategy of ordinary private equity funds is to obtain a controlling stake in the company in which they invest, including the investors we often hear about to get a board seat, to put all kinds of pressure on the founders, are all the manifestations of control. After gaining control, private equity funds take steps to improve company performance, thus allowing the invested company to generate substantial profits.

Hedge funds, by contrast, have little industry focus and are only interested in making a profit as quickly as possible and moving on to the next promising investment.

4. Number of contributions

Although private equity funds have a long lock-in time, the investment is not made at once, so LPs need to wait for the GP's call, which is called capital call or drawdown in the jargon. This actually has a lot of advantages from the fund's point of view, so that the fund won't have too much money at the beginning, which can improve Internal Rate of Return (IRR) Internal Rate of Return (IRR) and Total Value to Paid-in Capital (TVPI), two key performance indices. From the LP's point of view, there is no pressure to invest too much capital at the beginning, and if there are some projects that can be withdrawn in a relatively short period of time, i.e., distribution, then the LP will have the opportunity to use the funds from the distribution to invest in the next capital call, thus realizing the recycling of funds.

Hedge funds, on the other hand, because of the short investment cycle, need to pay all the capital at once.

5. Fee structure

Whether it is a private equity fund or a hedge fund, the management fee and the performance fee are all based on the law of Two Twenty.

However, it should be noted that the performance fee of hedge funds is based on the concept of high water mark.

That is, the portion of a hedge fund's performance fee that the fund manager can earn is based on the fund's historical performance, and the fund manager can only earn the portion of the performance fee between the previous peak and the next peak each time the fund reaches the next peak. For example, if the fund loses 5% from its previous high, the fund manager needs to first make up the 5% loss before collecting the incentive fee.

In contrast, private equity funds use a hurdle rate, which is a rate written into the private equity fund's investment agreement, usually 8%, rather than being based on the fund's prior performance. Every time you make a DISTRIBUTION allocation, you look to see if the combined rate for the period is higher than the hurdle rate, and if it is then the fund manager gets the higher portion of the performance fee.

6. Taxes

Every year, investors in both hedge funds and private equity funds file their individual tax returns with a Schedule K-1. The difference, however, is that hedge funds, because of their short cycle, are usually subject to a short-term capital gains tax, which, like the general income tax, is ultra-progressive, and because hedge funds are very large, the gains portion usually reaches the top bracket of the ultra-progressive tax rate, which is close to 50%. Private equity, on the other hand, because of its long-term nature, is all subject to long-term capital gains tax, which is 20%.

To answer one last question, why are hedge funds so mysterious? Why can't we buy hedge funds? As we said earlier, all private equity funds are required to be at least qualified investors accredited investor to invest, hedge funds are the same. And qualified investors of 1 million dollars that standard is only a minimum standard, usually private equity funds will set a higher threshold, such as the starting investment is 1 million dollars. Hedge funds tend to set a higher threshold, usually hedge funds will be set up for each person 10 million dollars of the starting investment, that is, is not that your personal net worth of 10 million dollars, but can take out 10 million dollars of free money or a one-time into the hedge fund. So we ordinary people for hedge funds just heard of the level.

Private equity fund 20 lectures, Silicon Valley investor's legal must study, I am American lawyer Liu Xiaoxiao.