difference between prilvate equity, hedge fund, and bulge bracket?

beard_tax
Tue, 06 Apr 2010 18:06:42 +0000

First, private equity firms and hedge funds are called the buy-side of finance. They provide the capital for companies to expand their operations. The capital comes from high net worth individuals and these firms use debt in order to increase their returns. (Look up leverage)

Private Equity firms buy out an entire company (Leverage Buyout) by using a mix of debt and equity. Essentially, the private equity firm is a holding company (think Berkshire Hathaway) for smaller companies they completely own. They invest wealthy individual’s money and try to improve the operations and financials of a company so that they can sell it for a profit. Private Equity firms are quite traditional and hire Investment Bankers who have M&A experience.

Hedge Funds are similar to private equity firms in that they take wealth people’s money and invest it in order to generate returns. However, they don’t buy out an entire company and usually trade in public shares. They also can invest in financial derivatives and a vast array of securities. Hedge funds are seen as less traditional because some of the largest funds in the world are modeled and traded by computer algorithms, such as D.E. Shaw and AQR Capital Management.

Bulge Bracket Investment Banks are the largest investment banks in the world. These IB are different from commercial banks because they primarily deal with the issuance of securities, which commercial banks (up until 1999) were not allowed to do because of the Glass-Steagall Act following the crash of 1929. They tend to be middle-men and are termed the “sell-side” of finance or simply, financial services. They sit between those who have capital and those who need capital. The whole investment bank is a well-oiled machine which allows large companies to access the capital markets (think Hedge Funds and wealthy people who have money or capital).

1) The investment bankers come up with a new deal they need to sell (IPO, M&A, other issuance). These guys form the core of the traditional investment bank and make the deals happen.

2) The Sales and Trading desk price the stuff that the investment bankers created and the sales force starts pitching it to their clients (wealthy people and hedge funds). The firm also provides liquidity (allows people to buy and sell this stuff easily) and takes a cut out of that as well (bid-ask spread).

3) The research guys publish a glowing report of the stuff they just issued saying how it’ll go up “X%” and how it will outperform the market.

Thus, the investment bank has created a deal, sold it to clients, and supported it through their research desk, while taking a healthy cut of the deal. All in a day’s work.

However, these investment banks tend not to do their core activities (connecting capital with investors) and instead, have chosen to principally invest their own profits and capital into ventures. Goldman Sachs generates huge revenues through their own hedge fund and private equity fund. That’s why the definition of investment banks is quite convoluted. They do so many activities, but their core function is what I have described above.

Private Equity firms and Hedge Funds usually do not hire straight out of undergrad. Most people on the buy-side of finance have sell-side experience so the way to break in is through the bulge bracket investment bank. In terms of recruitment, the investment banks usually look at the top 20 schools in the nation. They take the best and the brightest, and shape them into investment bankers, traders, or researchers. This usually means under-utilizing and abusing these students to make them into highly-paid, arrogant monkeys (Investment Bankers at least)

The salaries in each of these fields is quite ridiculous. Starting salaries for investment banking analysts is 50-60K and depending on performance of their group and company, their final salary can be 80-120K. However, the gravy train starts rolling in once you get promoted to higher levels of management. The food chain goes Analyst, Associate, Vice President, Senior Vice President/Director, and Managing Director. You can expect doubling of salary each level you go. Once you hit MD, there’s not limit to how much money you can make and how many naive souls you can crush.

The buy-side tends to have higher salaries. I’m not sure about Hedge Funds but some of the richest people in the world are hedge fund managers. I’m sure private equity employees make a lot of money but I don’t think the best make quite as much as the best in the hedge fund industry.