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2013 Business Expense Benchmark Survey
awarded to the General Partners (GPs) in the form of
incentive fee payouts. Our calculations on operating
margin are highlighted in Chart 6.
The figures clearly illustrate how difficult it is for
emerging hedge fund firms to become established.
By our calculations, survey participants with $100
million AUM would lose an average of 86 basis points
at the management company level. These losses are
likely to lessen, but continue until assets near the
$300 million mark, which is where our analysis places
break-even for the industry. Even with AUM reaching
$500 million, firms would be realizing margins of only
69 basis points. Indeed, for all the funds across our
pool of emerging survey participants, the average
operating margin equated to only 9 basis points.
These economics shift to a more favorable position as
firms surpass the $1.0 billion institutional threshold.
Our analysis shows firms with $1.5 billion AUM earn
an operating margin of 92 basis points, a figure 33%
higher than for firms at $500 million AUM. This is a
significant jump in profitability, but from this point
forward, growth in margins flattens.
Chart 6 shows how little margins change at various
AUM bands within the institutional category. Between
$1.5 billion and $5.0 billion AUM, operating margins
increase from 92 to 95 basis points—a gain of 4%
against a 3.3x increase in AUM. The gain noted
between $5.0 and $10.0 billion AUM is somewhat
better, as margins increase from 95 to 108 basis
points—a gain of 13% against a 2x increase in AUM.
Taken collectively, average operating margins for the
institutional category are 99 basis points.
Even at the significantly higher $36.0 billion AUMmark
(the average for our >$10.0 billion AUM category), our
model shows operating margins have only risen to 119
basis points—a gain of 10.0% against a 3.6x increase
in AUM.
While the growth in operating margins is limited after
a fund surpasses $1.0 billion AUM, the base against
which these profits are realized becomes increasingly
higher. This results in very large dollar margins for
the industry’s biggest hedge funds. Yet, only a small
subset of hedge fund firms reaches those bands at
which the profitability of their management company
is an attractive financial proposition.
Chart 7 shows that there is very little excess cash
generated by the management company even at the
top of the emerging category, as firms with $500
million AUM are only clearing an estimated $3.4
million annually. Even at $1.5 billion AUM, that figure
increases to only $13.7 million in profits. While this
is a very large amount of money, it does not mesh
Chart 7: Firm Profitability Based on Average Management Company Fees & Expenses
$100M
$500M
$1.5B
$5B
$10B
>$10B
$200M
$300M
$350M
$400M
$450M
$500M
Source: Citi Prime Finance. Total dataset examined (124 firms, $465 billion AUM)
Average AUM $36.4B
EMERGING
INSTITUTIONAL
FRANCHISE
$50M
$100M
$150M
Average:
-0.1% of AUM
Average:
1.0% of AUM
Average:
1.2% of AUM
-$862,000
$3.4M
$13.7M
$47.7M
$108.3M
$433.9M
$250M
PROFIT
$0
$50M