HEDGE FUNDS:

A hedge fund is an investment fund that is typically open to a limited range of investors who
pay a performance fee to the fund's investment manager.

Every hedge fund has its own investment strategy that determines the type of investments it
undertakes and these strategies are highly individual. As a class, hedge funds undertake a wider
range of investment and trading activities than traditional long-only investment funds, and invest
in a broader range of assets including long and short positions in shares, bonds and commodities.
As the name implies, hedge funds often seek to hedge some of the risks inherent in their
investments using a variety of methods, notably short selling and derivatives.

In most jurisdictions, hedge funds are open only to a limited range of professional or wealthy
investors who meet criteria set by regulators, and are accordingly exempted from many of the
regulations that govern ordinary investment funds. The net asset value of a hedge fund can run
into many billions of dollars, and the gross assets of the fund will usually be higher still due to
leverage. Hedge funds dominate certain specialty markets such as trading within derivatives with
high-yield ratings and distressed debt.[1]

[edit] History
Sociologist, author, and financial journalist Alfred W. Jones is credited with the creation of the
first hedge fund in 1949.[2] Jones believed that price movements of an individual asset could be
seen as having a component due to the overall market and a component due to the performance
of the asset itself. To neutralize the effect of overall market movement, he balanced his portfolio
by buying assets whose price he expected to be stronger than the market and selling short assets
he expected to be weaker than the market. He saw that price movements due to the overall
market would be cancelled out, because, if the overall market rose, the loss on shorted assets
would be cancelled by the additional gain on longed assets and vice-versa. Because the effect is
to 'hedge' that part of the risk due to overall market movements, this type of portfolio became
known as a hedge fund.

[edit] Industry size

Estimates of industry size vary widely due to the absence of central statistics, the lack of an
agreed definition of hedge funds and the rapid growth of the industry. As a general indicator of
scale, the industry may have managed around $2.5 trillion at its peak in the summer of 2008.[2]
The credit crunch has caused assets under management (AUM) to fall sharply through a
combination of trading losses and the withdrawal of assets from funds by investors.[3] Recent
estimates suggest that hedge funds have more than $2 trillion in AUM.[4] A recent survey of
hedge fund administrators indicates single manager hedge funds have over $2.5 trillion in assets
under administration ($AuA)[5] [6]
[edit] Largest hedge fund managers

The 25 largest hedge fund managers had $519.7 billion in assets under management as of
December 31, 2009. The largest manager is JP Morgan Chase ($53.5 billion) followed by
Bridgewater Associates ($43.6 billion), Paulson & Co. ($32 billion), Brevan Howard ($27
billion), and Soros Fund Management ($27 billion).[7]

[edit] Fees
A hedge fund manager will typically receive both a management fee and a performance fee (also
known as an incentive fee) from the fund. A typical manager may charge fees of "2 and 20",
which refers to a management fee of 2% of the fund's net asset value each year and a
performance fee of 20% of the fund's profit.[2]

[edit] Management fees

As with other investment funds, the management fee is calculated as a percentage of the fund's
net asset value. Management fees typically range from 1% to 4% per annum, with 2% being the
standard figure.[8] [9] Management fees are usually expressed as an annual percentage, but
calculated and paid monthly or quarterly.

The business models of most hedge fund managers provide for the management fee to cover the
operating costs of the manager, leaving the performance fee for employee bonuses. However, the
management fees for large funds may form a significant part of the manager's profits.[10]
Management fees associated with hedge funds have been under much scrutiny, with several large
public pension funds, notably CalPERS, calling on managers to reduce fees.

[edit] Performance fees

Performance fees (or "incentive fees") are one of the defining characteristics of hedge funds. The
manager's performance fee is calculated as a percentage of the fund's profits, usually counting
both realized and unrealized profits. By motivating the manager to generate returns, performance
fees are intended to align the interests of manager and investor more closely than flat fees. In the
business models of most managers, the performance fee is largely available for staff bonuses and
so can be extremely lucrative for managers who perform well. Several publications provide
estimates of the annual earnings of top hedge fund managers.[11][12] Typically, hedge funds charge
20% of returns as a performance fee.[13] However, the range is wide with highly regarded
managers charging higher fees. For example Steven Cohen's SAC Capital Partners charges a 35-
50% performance fee,[14] while Jim Simons' Medallion Fund charged a 45% performance fee.

Average incentive fees have declined since the start of the financial crisis, with the decline being
more pronounced in funds of hedge funds (FOFs). Incentive fees for single manager funds fell to
19.2 percent (versus 19.34 percent in Q1 08) while FOFs fell to 6.9 percent (versus 8.05 percent
in Q1 08). The average incentive fee for funds launched in 2009 was 17.6 percent, 1.6 percent
below the broader industry average.[15]
Performance fees have been criticized by many people, including notable investor Warren
Buffett, who believe that, by allowing managers to take a share of profit but providing no
mechanism for them to share losses, performance fees give managers an incentive to take
excessive risk rather than targeting high long-term returns. In an attempt to control this problem,
fees are usually limited by a high water mark.

[edit] High water marks

A high water mark (or "loss carryforward provision") is often applied to a performance fee
calculation. This means that the manager receives performance fees only on increases in the net
asset value (NAV) of the fund in excess of the highest net asset value it has previously achieved.
For example, if a fund were launched at a NAV per share of $100, which then rose to $120 in its
first year, a performance fee would be payable on the $20 return for each share. If the next year it
dropped to $110, no fee would be payable. If in the third year the NAV per share rose to $130, a
performance fee would be payable only on the $10 profit from $120 (the high water mark) to
$130, rather than on the full return during that year from $110 to $130.

The mechanism does not provide complete protection to investors: A manager who has lost a
significant percentage of the fund's value may close the fund and start again with a clean slate,
rather than continue working for no performance fee until the loss has been made up.[16] This
tactic is dependent on the manager's ability to persuade investors to trust him or her with their
money in the new fund.

[edit] Hurdle rates

Some managers specify a hurdle rate, signifying that they will not charge a performance fee until
the fund's annualized performance exceeds a benchmark rate, such as T-bill yield, LIBOR or a
fixed percentage.[2] This links performance fees to the ability of the manager to provide a higher
return than an alternative, usually lower risk, investment.

With a "soft" hurdle, a performance fee is charged on the entire annualized return if the hurdle
rate is cleared. With a "hard" hurdle, a performance fee is only charged on returns above the
hurdle rate. Before the credit crisis of 2008, demand for hedge funds tended to outstrip supply,
making hurdle rates relatively rare.[citation needed]

[edit] Withdrawal/redemption fees

Some funds charge investors a redemption fee (or "withdrawal fee" or "surrender charge") if they
withdraw money from the fund. A redemption fee is often charged only during a specified period
of time (typically a year) following the date of investment, or only to withdrawals representing a
specified portion of an investment.[17]

The purpose of the fee is to discourage short-term investment in the fund, thereby reducing
turnover and allowing the use of more complex, illiquid or long-term strategies. The fee may
also dissuade investors from withdrawing funds after periods of poor performance.
Unlike management and performance fees, redemption fees are usually retained by the fund and
therefore benefit the remaining investors rather than the manager.

[edit] Strategies
Hedge funds employ many different trading strategies, which are classified in many different
ways. No standard system is used. A hedge fund will typically commit itself to a particular
strategy, particular investment types and leverage limits via statements in its offering
documentation, thereby giving investors some indication of the nature of the particular fund.

Each strategy can be said to be built from a number of different elements:

 Style: global macro, directional, event-driven, relative value (arbitrage), managed futures
(CTA)
 Market: equity, fixed income, commodity, currency
 Instrument: long/short, futures, options, swaps
 Exposure: directional, market neutral
 Sector: emerging market, technology, healthcare etc.
 Method: discretionary/qualitative (where the individual investments are selected by
managers), systematic/quantitative (or "quant" - where the investments are selected
according to numerical methods using a computerized system)
 Diversification: multi-manager, multi-strategy, multi-fund, multi-market

The four main strategy groups are based on the investment style and have their own risk and
return characteristics. The most common label for a hedge fund is "long/short equity", meaning
that the fund takes both long and short positions in shares traded on public stock exchanges.

[edit] Global macro

(Macro, Trading) Global Macro funds attempt to anticipate global macroeconomic events,
generally using all markets and instruments to generate a return.

 Discretionary macro - instead of being generated by software, trading is carried out by

investment managers selecting investments.
 Systematic macro - trading is carried out using mathematical models and executed by
software without any human intervention other than the initial programming of the
software.
o Commodity Trading Advisors (CTA, Managed futures, Trading) - the fund
trades in futures (or options) in commodity markets.
o Systematic diversified - the fund trades in diversified markets.
o Systematic currency - the fund trades in currency markets.
o Trend following - the fund attempts to profit from following long-term or short-
term trends.
o Non-trend following (Counter trend) - the fund attempts to profit from
anticipating reversals in such trends.
  Multi-strategy - the fund uses a combination of strategies.

[edit] Directional

(Equity hedge) Hedged investments with exposure to the equity market.

 Long/short equity (Equity hedge) - long equity positions hedged with short sales of
stocks or stock market index options.
 Emerging markets - specialized in emerging markets, such as China, India etc.
 Sector funds - expertise in niche areas such as technology, healthcare, biotechnology,
pharmaceuticals, energy, basic materials.
 Fundamental growth - invest in companies with more earnings growth than the broad
equity market.
 Fundamental value - invest in undervalued companies.
 Quantitative Directional - equity trading using quantitative techniques.
 Short bias - take advantage of declining equity markets using short positions.
 Multi-strategy - diversification through different styles to reduce risk.

[edit] Event-driven

(Special situations) Exploit pricing inefficiencies caused by anticipated specific corporate events.

 Distressed securities (Distressed debt) - specialized in companies trading at discounts to

their value because of (potential) bankruptcy.
 Merger arbitrage (Risk arbitrage) - exploit pricing inefficiencies between merging
companies.
 Special situations - specialized in restructuring companies or companies engaged in a
corporate transaction.
 Multi-strategy - diversification through different styles to reduce risk.
 Credit arbitrage - specialized in corporate fixed income securities.
 Regulation D - specialized in private equities.
 Activist - take large positions in companies and use the ownership to be active in the
management.
 Legal Catalysts - specialized in companies involved in major lawsuits.

[edit] Relative value

(Arbitrage, Market neutral) Exploit pricing inefficiencies between related assets that are
mispriced.

 Fixed income arbitrage - exploit pricing inefficiencies between related fixed income
securities.
 Equity market neutral (Equity arbitrage) - being market neutral by maintaining a close
balance between long and short positions.
  Convertible arbitrage - exploit pricing inefficiencies between convertible securities and
the corresponding stocks.
 Fixed income corporate - fixed income arbitrage strategy using corporate fixed income
instruments.
 Asset-backed securities (Fixed-Income asset-backed) - fixed income arbitrage strategy
using asset-backed securities.
 Credit long / short - as long / short equity but in credit markets instead of equity
markets.
 Statistical arbitrage - equity market neutral strategy using statistical models.
 Volatility arbitrage - exploit the change in implied volatility instead of the change in
price.
 Yield alternatives - non-fixed income arbitrage strategies based on the yield instead of
the price.
 Multi-strategy - diversification through different styles to reduce risk.
 Regulatory arbitrage - the practice of taking advantage of regulatory differences
between two or more markets.

[edit] Miscellaneous

 Fund of hedge funds (Multi-manager) - a hedge fund with a diversified portfolio of

numerous underlying hedge funds.
 Fund of fund of hedge funds (F3, F cube) - a fund invested in other funds of hedge
funds.
 Multi-strategy - a hedge fund exploiting a combination of different hedge fund strategies
to reduce market risk.
 Multi-manager - a hedge fund wherein the investment is spread along separate sub-
managers investing in their own strategy.
 130-30 funds - unhedged equity fund with 130% long and 30% short positions, the
market exposure is 100%.
 Long-only absolute return funds - partly hedged fund excluding short selling but allow
derivatives.

[edit] Hedge fund risk

Despite a "hedge" being a means of reducing the risk of a bet or investment, investing in certain
types of hedge fund can be a riskier proposition than investing in a regulated fund. Many hedge
funds have some of these characteristics:

Leverage - in addition to money invested into the fund by investors, a hedge fund will
typically borrow money or trade on margin, with certain funds borrowing sums many
times greater than the initial investment. If a hedge fund has borrowed $9 for every $1
received from investors, a loss of only 10% of the value of the investments of the hedge
fund will wipe out 100% of the value of the investor's stake in the fund, once the
creditors have called in their loans. In September 1998, shortly before its collapse, Long-
Term Capital Management had $125 billion of assets on a base of $4 billion of investors'
 money, a leverage of over 30 times. It also had off-balance sheet positions with a notional
value of approximately $1 trillion.[18]
Short selling - due to the nature of short selling, the losses that can be incurred on a
losing bet are in theory limitless, unless the short position directly hedges a
corresponding long position. Ordinary funds very rarely use short selling in this way.
Appetite for risk - hedge funds are more likely than other types of funds to take on
underlying investments that carry high degrees of risk, such as high yield bonds,
distressed securities, and collateralized debt obligations based on sub-prime mortgages.
Lack of transparency - hedge funds are private entities with few public disclosure
requirements. It can therefore be difficult for an investor to assess trading strategies,
diversification of the portfolio, and other factors relevant to an investment decision.
Lack of regulation - hedge fund managers are, in some jurisdictions, not subject to as
much oversight from financial regulators as regulated funds, and therefore some may
carry undisclosed structural risks.
Short volatility - certain hedge fund strategies involve writing out of the money call or
put options. If these expire in the money the fund may take large losses.
Conflict of Interest - Inherent within the concept of paying a performance fee is the
notion that an investment advisor may construct a portfolio of higher risk than would
otherwise be taken, in hopes of increasing return and therefore performance fees.

Investors in hedge funds are, in most countries, required to be sophisticated investors who are
assumed to be aware of these risks, and willing to take these risks because of the corresponding
rewards:

 leverage amplifies profits as well as losses;

 short selling opens up new investment opportunities;
 riskier investments typically provide higher returns;
 secrecy helps to prevent imitation by competitors; and
 being unregulated reduces costs and allows the investment manager more freedom to
make decisions on a purely commercial basis.

One approach to diagnosing hedge fund risk is operational due diligence.

[edit] Hedge fund structure

A hedge fund is a vehicle for holding and investing the money of its investors. The fund itself
has no employees and no assets other than its investment portfolio and cash. The portfolio is
managed by the investment manager, a separate entity which is the actual business and has
employees.

As well as the investment manager, the functions of a hedge fund are delegated to a number of
other service providers. The most common service providers are:

Prime broker – prime brokerage services include lending money, acting as counterparty
to derivative contracts, lending securities for the purpose of short selling, trade execution,
 clearing and settlement. Many prime brokers also provide custody services. Prime
brokers are typically parts of large investment banks.
Administrator – the administrator typically deals with the issue and redemption of
interests and shares, calculates the net asset value of the fund, and performs related back
office functions. In some funds, particularly in the U.S., some of these functions are
performed by the investment manager, a practice that gives rise to a potential conflict of
interest inherent in having the investment manager both determine the NAV and benefit
from its increase through performance fees. Outside of the U.S., regulations often require
this role to be taken by a third party.
Distributor - the distributor is responsible for marketing the fund to potential investors.
Frequently, this role is taken by the investment manager.

[edit] Domicile

The legal structure of a specific hedge fund – in particular its domicile and the type of legal
entity used – is usually determined by the tax environment of the fund’s expected investors.
Regulatory considerations will also play a role. Many hedge funds are established in offshore
financial centres so that the fund can avoid paying tax on the increase in the value of its
portfolio. An investor will still pay tax on any profit it makes when it realizes its investment, and
the investment manager, usually based in a major financial centre, will pay tax on the fees that it
receives for managing the fund.

An IFSL Research report states: "Around 60% of the number of hedge funds in 2009 were
registered in offshore locations. The Cayman Islands was the most popular registration location
and accounted for 39% of the number of global hedge funds. It was followed by Delaware (US)
27%, British Virgin Islands 7% and Bermuda 5%. Around 5% of global hedge funds are
registered in the EU, primarily in Ireland and Luxembourg."[19]

[edit] Investment manager locations

In contrast to the funds themselves, investment managers are primarily located onshore in order
to draw on the major pools of financial talent and to be close to investors. With the bulk of hedge
fund investment coming from the U.S. East coast – principally New York City and the Gold
Coast aruea of Connecticut – this has become the leading location for hedge fund managers. It
was estimated there were 7,000 investment managers in the United States in 2004.[20]

London is Europe’s leading centre for hedge fund managers, with three-quarters of European
hedge fund investments, about $400 billion, at the end of 2009. Asia, and more particularly
China, is taking on a more important role as a source of funds for the global hedge fund industry.
The UK and the U.S. are leading locations for management of Asian hedge funds' assets with
around a quarter of the total each.[21]

[edit] The legal entity

Limited partnerships are principally used for hedge funds aimed at US-based investors who pay
tax, as the investors will receive relatively favorable tax treatment in the US. The general partner
of the limited partnership is typically the investment manager (though is sometimes an offshore
corporation) and the investors are the limited partners. Offshore corporate funds are used for
non-U.S. investors, which would otherwise be subject to more complex tax issues by investing in
a tax-transparent entity such as a partnership, and U.S. entities that do not pay tax such as
pension funds, which would otherwise be subject to unrelated business income tax in the United
States. Unit trusts are sometimes used to market to Japanese investors. Other than taxation, the
type of entity used does not have a significant bearing on the nature of the fund.

Many hedge funds are structured as master-feeder funds. In such a structure, the investors will
invest into a feeder fund, which will, in turn, invest all of its assets into the master fund. The
assets of the master fund will then be managed by the investment manager in the usual way. This
allows several feeder funds (e.g. an offshore corporate fund, a U.S. limited partnership and an
entity established for a particular investor) to invest into the same master fund, allowing an
investment manager the benefit of managing the assets of a single entity while giving all
investors the best possible tax treatment. The master fund will be tax-transparent for US tax
purposes.

The investment manager, which will have organized the establishment of the hedge fund, may
retain an interest in the hedge fund, either as the general partner of a limited partnership or as the
holder of “founder shares” in a corporate fund. Founder shares typically have no economic
rights, and voting rights over only a limited range of issues, such as selection of the investment
manager. The fund’s strategic decisions are taken by the board of directors of the fund, which is
independent but generally loyal to the investment manager.

[edit] Open-ended nature

Hedge funds are typically open-ended, meaning that the fund will periodically accept further
investment and allow investors to withdraw their money from the fund. For a fund structured as a
company, shares will be both issued and redeemed at the net asset value (“NAV”) per share, so
that if the value of the underlying investments has increased (and the NAV per share has
therefore also increased) then the investor will receive a larger sum on redemption than it paid on
investment. Similarly, where a fund is structured as a limited partnership the investor's account
will be allocated its proportion of any increase or decrease in the NAV of the fund, allowing an
investor to withdraw more (or less) when it withdraws its capital.

Investors do not typically trade shares or limited partnership interests among themselves and
hedge funds do not typically distribute profits to investors before redemption. This contrasts with
a closed-ended fund, which either has a limited number of shares which are traded among
investors, and which distributes its profits, or which has a limited lifespan at the end of which
capital is returned to investors.

[edit] Side pockets

Where a hedge fund holds assets that are hard to value reliably or are relatively illiquid (in
comparison to the redemption terms of the fund itself), the fund may employ a "side pocket". A
side pocket is a mechanism whereby the fund segregates the illiquid assets from the main
portfolio of the fund and issues investors with a new class of interests or shares which participate
only in the assets in the side pocket. Those interests/shares cannot be redeemed by the investor.
Once the fund is able to sell the side pocket assets, the fund will generally redeem the side
pocket interests/shares and pay investors the proceeds.

Side pockets are designed to address issues relating to the need to value investors' holdings in the
fund if they choose to redeem. If an investor redeems when certain assets cannot be valued or
sold, the fund cannot be confident that the calculation of his redemption proceeds would be
accurate. Moreover, his redemption proceeds could only be obtained by selling the liquid assets
of the fund. If the illiquid assets subsequently turned out to be worth less than expected, the
remaining investors would bear the full loss while the redeemed investor would have borne none.
Side pockets therefore allow a fund to ensure that all investors in the fund at the time the relevant
assets became illiquid will bear any loss on them equally and allow the fund to continue
subscriptions and redemptions in the meantime in respect of the main portfolio. A similar
problem, inverted, applies to subscriptions during the same period.

Side pockets are most commonly used by funds as an emergency measure. They were used
extensively following the collapse of Lehman Brothers in September 2008, when the market for
certain types of assets held by hedge funds collapsed, preventing the funds from selling or
obtaining a market value for the assets.

Specific types of fund may also use side pockets in the ordinary course of their business. A fund
investing in insurance products, for example, may routinely side pocket securities linked to
natural disasters following the occurrence of such a disaster. Once the damage has been assessed,
the security can again be valued with some accuracy.

[edit] Listed funds

Corporate hedge funds sometimes list their shares on smaller stock exchanges, such as the Irish
Stock Exchange, as this provides a low level of regulatory oversight that is required by some
investors. Shares in the listed hedge fund are not generally traded on the exchange.

A fund listing is distinct from the listing or initial public offering (“IPO”) of shares in an
investment manager. Although widely reported as a "hedge-fund IPO",[22] the IPO of Fortress
Investment Group LLC was for the sale of the investment manager, not of the hedge funds that it
managed.[23]

[edit] Regulatory issues

Part of what gives hedge funds their competitive edge, and their cachet in the public imagination,
is that they straddle multiple definitions and categories; some aspects of their dealings are well-
regulated, while others are unregulated or at best quasi-regulated.

[edit] U.S. regulation

The typical public investment company in the United States is required to be registered with the
U.S. Securities and Exchange Commission (SEC). Mutual funds are the most common type of
registered investment companies. Aside from registration and reporting requirements, investment
companies are subject to strict limitations on short-selling and the use of leverage. There are
other limitations and restrictions placed on public investment company managers, including the
prohibition on charging incentive or performance fees.

Although hedge funds are investment companies, they have avoided the typical regulations for
investment companies because of exceptions in the laws. The two major exemptions are set forth
in Sections 3(c)1 and 3(c)7 of the Investment Company Act of 1940. Those exemptions are for
funds with 100 or fewer investors (a "3(c) 1 Fund") and funds where the investors are "qualified
purchasers" (a "3(c) 7 Fund").[24] A qualified purchaser is an individual with over US$5,000,000
in investment assets. (Some institutional investors also qualify as accredited investors or
qualified purchasers.)[25] A 3(c)1 Fund cannot have more than 100 investors, while a 3(c)7 Fund
can have an unlimited number of investors. The Securities Act of 1933 disclosure requirements
apply only if the company seeks funds from the general public, and the quarterly reporting
requirements of the Securities Exchange Act of 1934 are only required if the fund has more than
499 investors.[26] A 3(c)7 fund with more than 499 investors must register its securities with the
SEC.[27]

In order to comply with 3(c)(1) or 3(c)(7), hedge funds raise capital via private placement under
the Securities Act of 1933, and normally the shares sold do not have to be registered under
Regulation D. Although it is possible to have non-accredited investors in a hedge fund,[citation needed]
the exemptions under the Investment Company Act, combined with the restrictions contained in
Regulation D, effectively require hedge funds to be offered solely to accredited investors.[28] An
accredited investor is an individual person with a minimum net worth of $1,000,000 or,
alternatively, a minimum income of US$200,000 in each of the last two years and a reasonable
expectation of reaching the same income level in the current year. For banks and corporate
entities, the minimum net worth is $5,000,000 in invested assets.[28]

There have been attempts to register hedge fund investment managers. There are numerous
issues surrounding these proposed requirements. A client who is charged an incentive fee must
be a "qualified client" under Advisers Act Rule 205-3. To be a qualified client, an individual
must have US$750,000 in assets invested with the adviser or a net worth in excess of US$1.5
million, or be one of certain high-level employees of the investment adviser.[29]

In December 2004, the SEC issued a rule change that required most hedge fund advisers to
register with the SEC by February 1, 2006, as investment advisers under the Investment Advisers
Act.[30] The requirement, with minor exceptions, applied to firms managing in excess of
US$25,000,000 with over 14 investors. The SEC stated that it was adopting a "risk-based
approach" to monitoring hedge funds as part of its evolving regulatory regimen for the
burgeoning industry.[31] The new rule was controversial, with two commissioners dissenting.[32]
The rule change was challenged in court by a hedge fund manager, and, in June 2006, the U.S.
Court of Appeals for the District of Columbia overturned it and sent it back to the agency to be
reviewed. See Goldstein v. SEC. In response to the court decision, in 2007 the SEC adopted Rule
206(4)-8. Rule 206(4)-8, unlike the earlier challenged rule, "does not impose additional filing,
reporting or disclosure obligations" but does potentially increase "the risk of enforcement action"
for negligent or fraudulent activity.[33]

In February 2007, the President's Working Group on Financial Markets rejected further
regulation of hedge funds and said that the industry should instead follow voluntary guidelines.
[34][35][36]
In November 2009 the House Financial Services Committee passed a bill that would
allow states to oversee hedge funds and other investment advisors with $100m or less in assets
under management, leaving larger investment managers up to the Securities and Exchange
Commission. Because the SEC currently regulates advisers with $25m or more under
management, the bill would shift 43% of these companies, or roughly 710, back over to state
oversight[37]

[edit] Comparison to U.S. private equity funds

Hedge funds are similar to private equity funds in many respects. Both are lightly regulated,
private pools of capital that invest in securities and compensate their managers with a share of
the fund's profits. Most hedge funds invest in relatively liquid assets, and permit investors to
enter or leave the fund, perhaps requiring some months notice. Private equity funds invest
primarily in very illiquid assets such as early-stage companies and so investors are "locked in"
for the entire term of the fund. Hedge funds often invest in private equity companies' acquisition
funds.[citation needed]

Between 2004 and February 2006, some hedge funds adopted 25-month lock-up rules expressly
to exempt themselves from the SEC's new registration requirements and cause them to fall under
the registration exemption that had been intended to exempt private equity funds.[citation needed]

[edit] Comparison to U.S. mutual funds

Like hedge funds, mutual funds are pools of investment capital (i.e., money people want to
invest). However, there are many differences between the two, including:

 Mutual funds are regulated by the SEC, while hedge funds are not
 A hedge fund investor must be an accredited investor with certain exceptions (employees,
etc.)
 Mutual funds must price and be liquid on a daily basis

Some hedge funds that are based offshore report their prices to the Financial Times, but for most
there is no method of ascertaining pricing on a regular basis. In addition, mutual funds must have
a prospectus available to anyone that requests one (either electronically or via U.S. postal mail),
and must disclose their asset allocation quarterly, whereas hedge funds do not have to abide by
these terms.

Hedge funds also ordinarily do not have daily liquidity, but rather "lock up" periods of time
where the total returns are generated (net of fees) for their investors and then returned when the
term ends, through a passthrough requiring CPAs and U.S. Tax W-forms. Hedge fund investors
tolerate these policies because hedge funds are expected to generate higher total returns for their
investors versus mutual funds.

Recently, however, the mutual fund industry has created products with features that have
traditionally been found only in hedge funds.

Mutual funds that utilize some of the trading strategies noted above have appeared. Grizzly Short
Fund (GRZZX), for example, is always net short, while Arbitrage Fund (ARBFX) specializes in
merger arbitrage. Such funds are SEC regulated, but they offer hedge fund strategies and
protection for mutual fund investors.

Also, a few mutual funds have introduced performance-based fees, where the compensation to
the manager is based on the performance of the fund. However, under Section 205(b) of the
Investment Advisers Act of 1940, such compensation is limited to so-called "fulcrum fees".[38]
Under these arrangements, fees can be performance-based so long as they increase and decrease
symmetrically.

For example, the TFS Capital Small Cap Fund (TFSSX) used to have a management fee that
behaved, within limits and symmetrically, similarly to a hedge fund "0 and 50" fee: A 0%
management fee coupled with a 50% performance fee if the fund outperformed its benchmark
index. However, the 125 bp base fee was reduced (but not below zero) by 50% of
underperformance and increased (but not to more than 250 bp) by 50% of outperformance.[39]

[edit] Proposed U.S. regulation

Hedge funds are exempt from regulation in the United States. Several bills have been introduced
in the 110th Congress (2007–08), however, relating to such funds. Among them are:

 S. 681, a bill to restrict the use of offshore tax havens and abusive tax shelters to
inappropriately avoid Federal taxation;
 H.R. 3417, which would establish a Commission on the Tax Treatment of Hedge Funds
and Private Equity to investigate imposing regulations;
 S. 1402, a bill to amend the Investment Advisors Act of 1940, with respect to the
exemption to registration requirements for hedge funds; and
 S. 1624, a bill to amend the Internal Revenue Code of 1986 to provide that the exception
from the treatment of publicly traded partnerships as corporations for partnerships with
passive-type income shall not apply to partnerships directly or indirectly deriving income
from providing investment adviser and related asset management services.
 S. 3268, a bill to amend the Commodity Exchange Act to prevent excessive price
speculation with respect to energy commodities. The bill would give the federal regulator
of futures markets the resources to detect, prevent, and punish price manipulation and
excessive speculation.

None of the bills has received serious consideration yet.

[edit] UK regulation
Hedge funds managed by UK hedge fund managers are always incorporated outside the UK,
usually in an offshore location such as the Cayman Islands, and are not directly regulated by the
UK authorities. However, a hedge fund manager based in the UK is required to be authorised and
regulated by the UK's Financial Services Authority, and accordingly the UK hedge fund industry
is regulated.

As the UK is part of the European Union, the UK hedge fund industry will also be affected by
the EU's Directive on Alternative Investment Fund Managers.

[edit] Offshore regulation

Many offshore centers are keen to encourage the establishment of hedge funds. To do this they
offer some combination of professional services, a favorable tax environment, and business-
friendly regulation. Major centers include Cayman Islands, Dublin, Luxembourg, British Virgin
Islands, and Bermuda. The Cayman Islands have been estimated to be home to about 75% of
world’s hedge funds, with nearly half the industry's estimated $1.225 trillion AUM.[40]

Hedge funds have to file accounts and conduct their business in compliance with the
requirements of these offshore centres. Typical rules concern restrictions on the availability of
funds to retail investors (Dublin), protection of client confidentiality (Luxembourg) and the
requirement for the fund to be independent of the fund manager.

[edit] Hedge fund indices

This article needs additional citations for verification.
Please help improve this article by adding reliable references. Unsourced material may be challenged
and removed. (November 2008)

There are many indices that track the hedge fund industry, and these fall into three main
categories. In their historical order of development they are Non-investable, Investable and
Clone.

In traditional equity investment, indices play a central and unambiguous role. They are widely
accepted as representative, and products such as futures and ETFs provide investable access to
them in most developed markets. However hedge funds are illiquid, heterogeneous and
ephemeral, which makes it hard to construct a satisfactory index. Non-investable indices are
representative, but, due to various biases, their quoted returns may not be available in practice.
Investable indices achieve liquidity at the expense of limited representativeness. Clone indices
seek to replicate some statistical properties of hedge funds but are not directly based on them.
None of these approaches is wholly satisfactory.

[edit] Non-investable indices

Non-investable indices are indicative in nature, and aim to represent the performance of some
database of hedge funds using some measure such as mean, median or weighted mean from a
hedge fund database. The databases have diverse selection criteria and methods of construction,
and no single database captures all funds. This leads to significant differences in reported
performance between different indices.

Although they aim to be representative, non-investable indices suffer from a lengthy and largely
unavoidable list of biases.

Funds’ participation in a database is voluntary, leading to self-selection bias because those funds
that choose to report may not be typical of funds as a whole. For example, some do not report
because of poor results or because they have already reached their target size and do not wish to
raise further money.

The short lifetimes of many hedge funds means that there are many new entrants and many
departures each year, which raises the problem of survivorship bias. If we examine only funds
that have survived to the present, we will overestimate past returns because many of the worst-
performing funds have not survived, and the observed association between fund youth and fund
performance suggests that this bias may be substantial.

When a fund is added to a database for the first time, all or part of its historical data is recorded
ex-post in the database. It is likely that funds only publish their results when they are favorable,
so that the average performances displayed by the funds during their incubation period are
inflated. This is known as "instant history bias” or “backfill bias”.

[edit] Investable indices

Investable indices are an attempt to reduce these problems by ensuring that the return of the
index is available to shareholders. To create an investable index, the index provider selects funds
and develops structured products or derivative instruments that deliver the performance of the
index. When investors buy these products the index provider makes the investments in the
underlying funds, making an investable index similar in some ways to a fund of hedge funds
portfolio.

To make the index investable, hedge funds must agree to accept investments on the terms given
by the constructor. To make the index liquid, these terms must include provisions for
redemptions that some managers may consider too onerous to be acceptable. This means that
investable indices do not represent the total universe of hedge funds, and most seriously they
may under-represent more successful managers.

[edit] Hedge fund replication

The most recent addition to the field approach the problem in a different manner. Instead of
reflecting the performance of actual hedge funds they take a statistical approach to the analysis
of historic hedge fund returns, and use this to construct a model of how hedge fund returns
respond to the movements of various investable financial assets. This model is then used to
construct an investable portfolio of those assets. This makes the index investable, and in
principle they can be as representative as the hedge fund database from which they were
constructed.

However, they rely on a statistical modelling process. As replication indices have a relatively
short history it is not yet possible to know how reliable this process will be in practice, although
initially indications are that much of hedge fund returns can be replicated in this manner without
the problems of illiquidity, transparency and fraud that exist in direct hedge fund investments.

[edit] Debates and controversies

[edit] Systemic risk

Hedge funds came under heightened scrutiny as a result of the failure of Long-Term Capital
Management (LTCM) in 1998, which necessitated a bailout coordinated (but not financed) by
the U.S. Federal Reserve. Critics have charged that hedge funds pose systemic risks highlighted
by the LTCM disaster. The excessive leverage (through derivatives) that can be used by hedge
funds to achieve their return[41] is outlined as one of the main factors of the hedge funds'
contribution to systemic risk.

The ECB (European Central Bank) issued a warning in June 2006 on hedge fund risk for
financial stability and systemic risk: "... the increasingly similar positioning of individual hedge
funds within broad hedge fund investment strategies is another major risk for financial stability,
which warrants close monitoring despite the essential lack of any possible remedies. Some
believe that broad hedge fund investment strategies have also become increasingly correlated,
thereby further increasing the potential adverse effects of disorderly exits from crowded
trades."[42][43] However the ECB statement has been disputed by parts of the financial industry.[44]

The potential for systemic risk was highlighted by the near-collapse of two Bear Stearns hedge
funds in June 2007.[45] The funds invested in mortgage-backed securities. The funds' financial
problems necessitated an infusion of cash into one of the funds from Bear Stearns but no outside
assistance. It was the largest fund bailout since Long Term Capital Management's collapse in
1998. The U.S. Securities and Exchange commission is investigating.[46]

[edit] Transparency

As private, lightly regulated entities, hedge funds are not obliged to disclose their activities to
third parties. This is in contrast to a regulated mutual fund (or unit trust), which will typically
have to meet regulatory requirements for disclosure. An investor in a hedge fund usually has
direct access to the investment advisor of the fund, and may enjoy more personalized reporting
than investors in retail investment funds. This may include detailed discussions of risks assumed
and significant positions. However, this high level of disclosure is not available to non-investors,
contributing to hedge funds' reputation for secrecy, while some hedge funds have very limited
transparency even to investors. [47]

Funds may choose to report some information in the interest of recruiting additional investors.
Much of the data available in consolidated databases is self-reported and unverified.[48] A study
was done on two major databases containing hedge fund data. The study noted that 465 common
funds had significant differences in reported information (e.g. returns, inception date, net assets
value, incentive fee, management fee, investment styles, etc.) and that 5% of return numbers and
5% of NAV numbers were dramatically different.[49] With these limitations, investors have to do
their own research, which may cost on the scale of $50,000.[50]

Some hedge funds, mainly American, do not use third parties either as the custodian of their
assets or as their administrator (who will calculate the NAV of the fund). This can lead to
conflicts of interest, and in extreme cases can assist fraud. In a recent example, Kirk Wright of
International Management Associates has been accused of mail fraud and other securities
violations[51] which allegedly defrauded clients of close to $180 million.[52] In December 2008,
Bernard Madoff was arrested for running a $50 billion Ponzi scheme.[53] While Madoff did not
run a hedge fund, several hedge funds (so called feeder funds), of which the largest was Fairfield
Sentry, were overseen by Madoff and practically all their funds were funnelled to Madoff.

[edit] Market capacity

Alpha appears to have been becoming rarer for two related reasons. First, the increase in traded
volume may have been reducing the market anomalies that are a source of hedge fund
performance. Second, the remuneration model is attracting more managers, which may dilute the
talent available in the industry, though these causes are disputed.[54]

[edit] U.S. investigations

In June 2006, prompted by a letter from Gary J. Aguirre, the Senate Judiciary Committee began
an investigation into the links between hedge funds and independent analysts. Aguirre was fired
from his job with the SEC when, as lead investigator of insider trading allegations against Pequot
Capital Management, he tried to interview John Mack, then being considered for chief executive
officer at Morgan Stanley.[55] The Judiciary Committee and the U.S. Senate Finance Committee
issued a scathing report in 2007, which found that Aguirre had been illegally fired in reprisal[56]
for his pursuit of Mack and in 2009, the SEC was forced to re-open its case against Pequot.
Pequot settled with the SEC for $28 million and Arthur J. Samberg, chief investment officer of
Pequot, was barred from working as an investment advisor.[57] Pequot closed its doors under the
pressure of investigations.[58]

The SEC is focusing resources on investigating insider trading by hedge funds,[59][60] though a
statement by SEC Enforcement Director Robert Khuzami put some of its impact in question[61]
and Senator Chuck Grassley has asked for an explanation of Khuzami's remarks.[62]

[edit] Performance measurement

Performance statistics are hard to obtain because of restrictions on advertising and the lack of
centralized collection. However summaries are occasionally available in various journals.[63][64]

The question of how performance should be adjusted for the amount of risk that is being taken
has led to literature that is both abundant and controversial. Traditional indicators (Sharpe,
Treynor, Jensen) work best when returns follow a symmetrical distribution. In that case, risk is
represented by the standard deviation. Unfortunately, hedge fund returns are not normally
distributed, and hedge fund return series are autocorrelated. Consequently, traditional
performance measures suffer from theoretical problems when they are applied to hedge funds,
making them even less reliable than is suggested by the shortness of the available return series.[2]

Several innovative performance measures have been introduced in an attempt to deal with this
problem: Modified Sharpe ratio by Gregoriou and Gueyie (2003), Omega by Keating and
Shadwick (2002), Alternative Investments Risk Adjusted Performance (AIRAP) by Sharma
(2004), and Kappa by Kaplan and Knowles (2004). However, there is no consensus on the most
appropriate absolute performance measure, and traditional performance measures are still widely
used in the industry.[2]

[edit] Value in mean/variance efficient portfolios

According to Modern Portfolio Theory, rational investors will seek to hold portfolios that are
mean/variance efficient (that is, portfolios offer the highest level of return per unit of risk, and
the lowest level of risk per unit of return). One of the attractive features of hedge funds (in
particular market neutral and similar funds) is that they sometimes have a modest correlation
with traditional assets such as equities. This means that hedge funds have a potentially quite
valuable role in investment portfolios as diversifiers, reducing overall portfolio risk.[2]

However, there are three reasons why one might not wish to allocate a high proportion of assets
into hedge funds. These reasons are:

1. Hedge funds are highly individual and it is hard to estimate the likely returns or risks;
2. Hedge funds’ low correlation with other assets tends to dissipate during stressful market
events, making them much less useful for diversification than they may appear; and
3. Hedge fund returns are reduced considerably by the high fee structures that are typically
charged.

Several studies have suggested that hedge funds are sufficiently diversifying to merit inclusion in
investor portfolios, but this is disputed for example by Mark Kritzman[65][66] who performed a
mean-variance optimization calculation on an opportunity set that consisted of a stock index
fund, a bond index fund, and ten hypothetical hedge funds. The optimizer found that a mean-
variance efficient portfolio did not contain any allocation to hedge funds, largely because of the
impact of performance fees. To demonstrate this, Kritzman repeated the optimization using an
assumption that the hedge funds incurred no performance fees. The result from this second
optimization was an allocation of 74% to hedge funds.

The other factor reducing the attractiveness of hedge funds in a diversified portfolio is that they
tend to under-perform during equity bear markets, just when an investor needs part of their
portfolio to add value.[2] For example, in January-September 2008, the Credit Suisse/Tremont
Hedge Fund Index[67] was down 9.87%. According to the same index series, even "dedicated
short bias" funds had a return of -6.08% during September 2008. In other words, even though
low average correlations may appear to make hedge funds attractive this may not work in
turbulent period, for example around the collapse of Lehman Brothers in September 2008.

Hedge funds posted disappointing returns in 2008, but the average hedge fund return of -18.65%
(the HFRI Fund Weighted Composite Index return) was far better than the returns generated by
most assets other than cash. The S&P 500 total return was -37.00% in 2008, and that was one of
the best performing equity indices in the world. Several equity markets lost more than half their
value. Most foreign and domestic corporate debt indices also suffered in 2008, posting losses
significantly worse than the average hedge fund. Mutual funds also performed much worse than

HEDGE FUNDS:

hedge funds in 2008. According to Lipper, the average U.S. domestic equity mutual fund
decreased 37.6% in 2008. The average international equity mutual fund declined 45.8%. The
average sector mutual fund dropped 39.7%. The average China mutual fund declined 52.7% and
the average Latin America mutual fund plummeted 57.3%. Real estate, both residential and
commercial, also suffered significant drops in 2008. In summary, hedge funds outperformed
many similarly-risky investment options in 2008.

[edit] Notable hedge fund firms

 Bridgewater Associates
 Citadel Investment Group
 D.E. Shaw
 Fortress Investment Group
 GLG Partners
 Highbridge Capital Management
 Long-Term Capital Management
 Man Group
 Marshall Wace
 Renaissance Technologies
 SAC Capital Advisors
 Soros Fund Management
 The Children's Investment Fund Management (TCI)
PRIVATE EQUITY:

Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies
that are not publicly traded on a stock exchange.[1]

Among the most common investment strategies in private equity are: leveraged buyouts, venture
capital, growth capital, distressed investments and mezzanine capital. In a typical leveraged
buyout transaction, the private equity firm buys majority control of an existing or mature firm.
This is distinct from a venture capital or growth capital investment, in which the private equity
firm typically invests in young or emerging companies, and rarely obtain majority control.

[edit] Leveraged buyout

Main article: Leveraged buyout

Diagram of the basic structure of a generic leveraged buyout transaction

Leveraged buyout, LBO or Buyout refers to a strategy of making equity investments as part of a
transaction in which a company, business unit or business assets is acquired from the current
shareholders typically with the use of financial leverage. The companies involved in these
transactions are typically mature and generate operating cash flows.[2]

Leveraged buyouts involve a financial sponsor agreeing to an acquisition without itself

committing all the capital required for the acquisition. To do this, the financial sponsor will raise
acquisition debt which ultimately looks to the cash flows of the acquisition target to make
interest and principal payments.[3] Acquisition debt in an LBO is often non-recourse to the
financial sponsor and has no claim on other investment managed by the financial sponsor.
Therefore, an LBO transaction's financial structure is particularly attractive to a fund's limited
partners, allowing them the benefits of leverage but greatly limiting the degree of recourse of that
leverage. This kind of financing structure leverage benefits an LBO's financial sponsor in two
ways: (1) the investor itself only needs to provide a fraction of the capital for the acquisition, and
(2) the returns to the investor will be enhanced (as long as the return on assets exceeds the cost of
the debt).[4]

As a percentage of the purchase price for a leverage buyout target, the amount of debt used to
finance a transaction varies according the financial condition and history of the acquisition
target, market conditions, the willingness of lenders to extend credit (both to the LBO's financial
sponsors and the company to be acquired) as well as the interest costs and the ability of the
company to cover those costs. Historically the debt portion of a LBO will range from 60%–90%
of the purchase price, although during certain periods the debt ratio can be higher or lower than
the historical averages.[5] Between 2000–2005 debt averaged between 59.4% and 67.9% of total
purchase price for LBOs in the United States.[6]

[edit] Venture capital

Main article: Venture capital

Venture capital[7] is a broad subcategory of private equity that refers to equity investments made,
typically in less mature companies, for the launch, early development, or expansion of a
business. Venture investment is most often found in the application of new technology, new
marketing concepts and new products that have yet to be proven.[8][9]

Venture capital is often sub-divided by the stage of development of the company ranging from
early stage capital used for the launch of start-up companies to late stage and growth capital that
is often used to fund expansion of existing business that are generating revenue but may not yet
be profitable or generating cash flow to fund future growth.[10]

Entrepreneurs often develop products and ideas that require substantial capital during the
formative stages of their companies' life cycles.[11] Many entrepreneurs do not have sufficient
funds to finance projects themselves, and they must therefore seek outside financing.[12] The
venture capitalist's need to deliver high returns to compensate for the risk of these investments
makes venture funding an expensive capital source for companies. Venture capital is most
suitable for businesses with large up-front capital requirements which cannot be financed by
cheaper alternatives such as debt. Although venture capital is often most closely associated with
fast-growing technology and biotechnology fields, venture funding has been used for other more
traditional businesses.[8][13]

[edit] Growth capital

Main article: Growth capital

Growth capital refers to equity investments, most often minority investments, in relatively
mature companies that are looking for capital to expand or restructure operations, enter new
markets or finance a major acquisition without a change of control of the business.[citation needed]

Companies that seek growth capital will often do so in order to finance a transformational event
in their life cycle. These companies are likely to be more mature than venture capital funded
companies, able to generate revenue and operating profits but unable to generate sufficient cash
to fund major expansions, acquisitions or other investments. The primary owner of the company
may not be willing to take the financial risk alone. By selling part of the company to private
equity, the owner can take out some value and share the risk of growth with partners.[14] Capital
can also be used to effect a restructuring of a company's balance sheet, particularly to reduce the
amount of leverage (or debt) the company has on its balance sheet.[15] A Private investment in
public equity, or PIPEs, refer to a form of growth capital investment made into a publicly traded
company. PIPE investments are typically made in the form of a convertible or preferred security
that is unregistered for a certain period of time.[16][17] The Registered Direct, or RD, is another
common financing vehicle used for growth capital. A registered direct is similar to a PIPE but is
instead sold as a registered security.

[edit] Distressed and Special Situations

Main article: Distressed securities

Distressed or Special Situations is a broad category referring to investments in equity or debt

securities of financially stressed companies.[18][19][20] The "distressed" category encompasses two
broad sub-strategies including:

 "Distressed-to-Control" or "Loan-to-Own" strategies where the investor acquires debt

securities in the hopes of emerging from a corporate restructuring in control of the
company's equity;[21]
 "Special Situations" or "Turnaround" strategies where an investor will provide debt and
equity investments, often "rescue financing" to companies undergoing operational or
financial challenges.[22]

In addition to these private equity strategies, hedge funds employ a variety of distressed
investment strategies including the active trading of loans and bonds issued by distressed
companies.

[edit] Mezzanine capital

Main article: Mezzanine capital

Mezzanine capital refers to subordinated debt or preferred equity securities that often represent
the most junior portion of a company's capital structure that is senior to the company's common
equity. This form of financing is often used by private equity investors to reduce the amount of
equity capital required to finance a leveraged buyout or major expansion. Mezzanine capital,
which is often used by smaller companies that are unable to access the high yield market, allows
such companies to borrow additional capital beyond the levels that traditional lenders are willing
to provide through bank loans.[23] In compensation for the increased risk, mezzanine debt holders
require a higher return for their investment than secured or other more senior lenders.[24][25]

[edit] Secondaries

Main article: Private equity secondary market

Secondary investments refer to investments made in existing private equity assets. These
transactions can involve the sale of private equity fund interests or portfolios of direct
investments in privately held companies through the purchase of these investments from existing
institutional investors.[26] By its nature, the private equity asset class is illiquid, intended to be a
long-term investment for buy-and-hold investors. Secondary investments provide institutional
investors with the ability to improve vintage diversification, particularly for investors that are
new to the asset class. Secondaries also typically experience a different cash flow profile,
diminishing the j-curve effect of investing in new private equity funds.[27][28] Often investments in
secondaries are made through third party fund vehicle, structured similar to a fund of funds
although many large institutional investors have purchased private equity fund interests through
secondary transactions.[29] Sellers of private equity fund investments sell not only the investments
in the fund but also their remaining unfunded commitments to the funds.

[edit] Other strategies

Other strategies that can be considered private equity or a close adjacent market include:

 Real Estate: in the context of private equity this will typically refer to the riskier end of
the investment spectrum including "value added" and opportunity funds where the
investments often more closely resemble leveraged buyouts than traditional real estate
investments. Certain investors in private equity consider real estate to be a separate asset
class.

 Infrastructure: investments in various public works (e.g., bridges, tunnels, toll roads,
airports, public transportation and other public works) that are made typically as part of a
privatization initiative on the part of a government entity.[30][31][32]

 Energy and Power: investments in a wide variety of companies (rather than assets)
engaged in the production and sale of energy, including fuel extraction, manufacturing,
refining and distribution (Energy) or companies engaged in the production or
transmission of electrical power (Power).

 Merchant banking: negotiated private equity investment by financial institutions in the

unregistered securities of either privately or publicly held companies.[33]

[edit] History and development

 History of private equity
and venture capital

[edit] Early history and the development of venture capital

Main articles: History of private equity and venture capital and Early history of private equity

The seeds of the US private equity industry were planted in 1946 with the founding of two
venture capital firms: American Research and Development Corporation (ARDC) and J.H.
Whitney & Company.[34] Before World War II, venture capital investments (originally known as
"development capital") were primarily the domain of wealthy individuals and families. ARDC
was founded by Georges Doriot, the "father of venture capitalism"[35] and founder of INSEAD,
with capital raised from institutional investors, to encourage private sector investments in
businesses run by soldiers who were returning from World War II. ARDC is credited with the
first major venture capital success story when its 1957 investment of $70,000 in Digital
Equipment Corporation (DEC) would be valued at over $355 million after the company's initial
public offering in 1968 (representing a return of over 500 times on its investment and an
annualized rate of return of 101%).[36] It is commonly noted that the first venture-backed startup
is Fairchild Semiconductor (which produced the first commercially practicable integrated
circuit), funded in 1959 by what would later become Venrock Associates.[37]

[edit] Origins of the leveraged buyout

Main articles: History of private equity and venture capital and Early history of private equity

The first leveraged buyout may have been the purchase by McLean Industries, Inc. of Pan-
Atlantic Steamship Company in January 1955 and Waterman Steamship Corporation in May
1955[38] Under the terms of that transaction, McLean borrowed $42 million and raised an
additional $7 million through an issue of preferred stock. When the deal closed, $20 million of
Waterman cash and assets were used to retire $20 million of the loan debt.[39] Similar to the
approach employed in the McLean transaction, the use of publicly traded holding companies as
investment vehicles to acquire portfolios of investments in corporate assets was a relatively new
trend in the 1960s popularized by the likes of Warren Buffett (Berkshire Hathaway) and Victor
Posner (DWG Corporation) and later adopted by Nelson Peltz (Triarc), Saul Steinberg (Reliance
Insurance) and Gerry Schwartz (Onex Corporation). These investment vehicles would utilize a
number of the same tactics and target the same type of companies as more traditional leveraged
buyouts and in many ways could be considered a forerunner of the later private equity firms. In
fact it is Posner who is often credited with coining the term "leveraged buyout" or "LBO"[40]

The leveraged buyout boom of the 1980s was conceived by a number of corporate financiers,
most notably Jerome Kohlberg, Jr. and later his protégé Henry Kravis. Working for Bear Stearns
at the time, Kohlberg and Kravis along with Kravis' cousin George Roberts began a series of
what they described as "bootstrap" investments. Many of these companies lacked a viable or
attractive exit for their founders as they were too small to be taken public and the founders were
reluctant to sell out to competitors and so a sale to a financial buyer could prove attractive. Their
acquisition of Orkin Exterminating Company in 1964 is among the first significant leveraged
buyout transactions.[41] In the following years the three Bear Stearns bankers would complete a
series of buyouts including Stern Metals (1965), Incom (a division of Rockwood International,
1971), Cobblers Industries (1971), and Boren Clay (1973) as well as Thompson Wire, Eagle
Motors and Barrows through their investment in Stern Metals.[42] By 1976, tensions had built up
between Bear Stearns and Kohlberg, Kravis and Roberts leading to their departure and the
formation of Kohlberg Kravis Roberts in that year.

[edit] Private equity in the 1980s

Main articles: History of private equity and venture capital and Private equity in the 1980s

In January 1982, former United States Secretary of the Treasury William Simon and a group of
investors acquired Gibson Greetings, a producer of greeting cards, for $80 million, of which only
$1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen
months after the original deal, Gibson completed a $290 million IPO and Simon made
approximately $66 million.[43][44]

The success of the Gibson Greetings investment attracted the attention of the wider media to the
nascent boom in leveraged buyouts. Between 1979 and 1989, it was estimated that there were
over 2,000 leveraged buyouts valued in excess of $250 million[45]

During the 1980s, constituencies within acquired companies and the media ascribed the
"corporate raid" label to many private equity investments, particularly those that featured a
hostile takeover of the company, perceived asset stripping, major layoffs or other significant
corporate restructuring activities. Among the most notable investors to be labeled corporate
raiders in the 1980s included Carl Icahn, Victor Posner, Nelson Peltz, Robert M. Bass, T. Boone
Pickens, Harold Clark Simmons, Kirk Kerkorian, Sir James Goldsmith, Saul Steinberg and
Asher Edelman. Carl Icahn developed a reputation as a ruthless corporate raider after his hostile
takeover of TWA in 1985.[46][47][48] Many of the corporate raiders were onetime clients of Michael
Milken, whose investment banking firm, Drexel Burnham Lambert helped raise blind pools of
capital with which corporate raiders could make a legitimate attempt to take over a company and
provided high-yield debt ("junk bonds") financing of the buyouts.

One of the final major buyouts of the 1980s proved to be its most ambitious and marked both a
high water mark and a sign of the beginning of the end of the boom that had begun nearly a
decade earlier. In 1989, KKR closed in on a $31.1 billion takeover of RJR Nabisco. It was, at
that time and for over 17 years, the largest leverage buyout in history. The event was chronicled
in the book (and later the movie), Barbarians at the Gate: The Fall of RJR Nabisco. KKR would
eventually prevail in acquiring RJR Nabisco at $109 per share, marking a dramatic increase from
the original announcement that Shearson Lehman Hutton would take RJR Nabisco private at $75
per share. A fierce series of negotiations and horse-trading ensued which pitted KKR against
Shearson and later Forstmann Little & Co. Many of the major banking players of the day,
including Morgan Stanley, Goldman Sachs, Salomon Brothers, and Merrill Lynch were actively
involved in advising and financing the parties. After Shearson's original bid, KKR quickly
introduced a tender offer to obtain RJR Nabisco for $90 per share—a price that enabled it to
proceed without the approval of RJR Nabisco's management. RJR's management team, working
with Shearson and Salomon Brothers, submitted a bid of $112, a figure they felt certain would
enable them to outflank any response by Kravis's team. KKR's final bid of $109, while a lower
dollar figure, was ultimately accepted by the board of directors of RJR Nabisco.[49] At
$31.1 billion of transaction value, RJR Nabisco was by far the largest leveraged buyouts in
history. In 2006 and 2007, a number of leveraged buyout transactions were completed that for
the first time surpassed the RJR Nabisco leveraged buyout in terms of nominal purchase price.
However, adjusted for inflation, none of the leveraged buyouts of the 2006–2007 period would
surpass RJR Nabisco. By the end of the 1980s the excesses of the buyout market were beginning
to show, with the bankruptcy of several large buyouts including Robert Campeau's 1988 buyout
of Federated Department Stores, the 1986 buyout of the Revco drug stores, Walter Industries,
FEB Trucking and Eaton Leonard. Additionally, the RJR Nabisco deal was showing signs of
strain, leading to a recapitalization in 1990 that involved the contribution of $1.7 billion of new
equity from KKR.[50] In the end, KKR lost $700 million on RJR.[51]

Drexel reached an agreement with the government in which it pleaded nolo contendere (no
contest) to six felonies – three counts of stock parking and three counts of stock manipulation.[52]
It also agreed to pay a fine of $650 million – at the time, the largest fine ever levied under
securities laws. Milken left the firm after his own indictment in March 1989.[53][54] On 13
February 1990 after being advised by United States Secretary of the Treasury Nicholas F. Brady,
the U.S. Securities and Exchange Commission (SEC), the New York Stock Exchange and the
Federal Reserve, Drexel Burnham Lambert officially filed for Chapter 11 bankruptcy protection.
[53]

[edit] Age of the mega-buyout 2005–2007

Main articles: History of private equity and venture capital and Private equity in the 21st
centuryThe combination of decreasing interest rates, loosening lending standards and regulatory
changes for publicly traded companies (specifically the Sarbanes-Oxley Act) would set the stage
for the largest boom private equity had seen. Marked by the buyout of Dex Media in 2002, large
multi-billion dollar U.S. buyouts could once again obtain significant high yield debt financing
and larger transactions could be completed. By 2004 and 2005, major buyouts were once again
becoming common, including the acquisitions of Toys "R" Us,[55] The Hertz Corporation,[56][57]
Metro-Goldwyn-Mayer[58] and SunGard[59] in 2005.
As 2005 ended and 2006 began, new "largest buyout" records were set and surpassed several

times with nine of the top ten buyouts at the end of 2007 having been announced in an 18-month
window from the beginning of 2006 through the middle of 2007. In 2006, private equity firms
bought 654 U.S. companies for $375 billion, representing 18 times the level of transactions
closed in 2003.[60] Additionally, U.S. based private equity firms raised $215.4 billion in investor
commitments to 322 funds, surpassing the previous record set in 2000 by 22% and 33% higher
than the 2005 fundraising total[61] The following year, despite the onset of turmoil in the credit
markets in the summer, saw yet another record year of fundraising with $302 billion of investor
commitments to 415 funds[62] Among the mega-buyouts completed during the 2006 to 2007
boom were: Equity Office Properties, HCA,[63] Alliance Boots[64] and TXU.[65]
In July 2007, turmoil that had been affecting the mortgage markets, spilled over into the
leveraged finance and high-yield debt markets.[66][67] The markets had been highly robust during
the first six months of 2007, with highly issuer friendly developments including PIK and PIK
Toggle (interest is "Payable In Kind") and covenant light debt widely available to finance large
leveraged buyouts. July and August saw a notable slowdown in issuance levels in the high yield
and leveraged loan markets with few issuers accessing the market. Uncertain market conditions
led to a significant widening of yield spreads, which coupled with the typical summer slowdown
led many companies and investment banks to put their plans to issue debt on hold until the
autumn. However, the expected rebound in the market after 1 May 2007 did not materialize, and
the lack of market confidence prevented deals from pricing. By the end of September, the full
extent of the credit situation became obvious as major lenders including Citigroup and UBS AG
announced major writedowns due to credit losses. The leveraged finance markets came to a near
standstill.[68] As 2007 ended and 2008 began, it was clear that lending standards had tightened
and the era of "mega-buyouts" had come to an end. Nevertheless, private equity continues to be a
large and active asset class and the private equity firms, with hundreds of billions of dollars of
committed capital from investors are looking to deploy capital in new and different transactions.

[edit] Investments in private equity

Diagram of the structure of a generic private equity fund

Although the capital for private equity originally came from individual investors or corporations,
in the 1970s, private equity became an asset class in which various institutional investors
allocated capital in the hopes of achieving risk adjusted returns that exceed those possible in the
public equity markets. In the 1980s, insurers were major private equity investors. Later, public
pension funds and university and other endowments became more significant sources of capital.
[69]
For most institutional investors, private equity investments are made as part of a broad asset
allocation that includes traditional assets (e.g., public equity and bonds) and other alternative
assets (e.g., hedge funds, real estate, commodities).
Most institutional investors do not invest directly in privately held companies, lacking the
expertise and resources necessary to structure and monitor the investment. Instead, institutional
investors will invest indirectly through a private equity fund. Certain institutional investors have
the scale necessary to develop a diversified portfolio of private equity funds themselves, while
others will invest through a fund of funds to allow a portfolio more diversified than one a single
investor could construct.

Returns on private equity investments are created through one or a combination of three factors
that include: debt repayment or cash accumulation through cash flows from operations,
operational improvements that increase earnings over the life of the investment and multiple
expansion, selling the business for a higher multiple of earnings than was originally paid. A key
component of private equity as an asset class for institutional investors is that investments are
typically realized after some period of time, which will vary depending on the investment
strategy. Private equity investments are typically realized through one of the following avenues:

 an Initial Public Offering (IPO) – shares of the company are offered to the public,
typically providing a partial immediate realization to the financial sponsor as well as a
public market into which it can later sell additional shares;
 a merger or acquisition – the company is sold for either cash or shares in another
company;
 a Recapitalization – cash is distributed to the shareholders (in this case the financial
sponsor) and its private equity funds either from cash flow generated by the company or
through raising debt or other securities to fund the distribution.

[edit] Liquidity in the private equity market

Diagram of a simple secondary market transfer of a limited partnership fund interest. The buyer
exchanges a single cash payment to the seller for both the investments in the fund plus any
unfunded commitments to the fund.
Main article: Private equity secondary market

The private equity secondary market (also often called private equity secondaries) refers to the
buying and selling of pre-existing investor commitments to private equity and other alternative
investment funds. Sellers of private equity investments sell not only the investments in the fund
but also their remaining unfunded commitments to the funds. By its nature, the private equity
asset class is illiquid, intended to be a long-term investment for buy-and-hold investors. For the
vast majority of private equity investments, there is no listed public market; however, there is a
robust and maturing secondary market available for sellers of private equity assets.

Increasingly, secondaries are considered a distinct asset class with a cash flow profile that is not
correlated with other private equity investments. As a result, investors are allocating capital to
secondary investments to diversify their private equity programs. Driven by strong demand for
private equity exposure, a significant amount of capital has been committed to secondary
investments from investors looking to increase and diversify their private equity exposure.

Investors seeking access to private equity have been restricted to investments with structural
impediments such as long lock-up periods, lack of transparency, unlimited leverage,
concentrated holdings of illiquid securities and high investment minimums.

Secondary transactions can be generally split into two basic categories:

 Sale of Limited Partnership Interests – The most common secondary transaction, this
category includes the sale of an investor's interest in a private equity fund or portfolio of
interests in various funds through the transfer of the investor's limited partnership interest
in the fund(s). Nearly all types of private equity funds (e.g., including buyout, growth
equity, venture capital, mezzanine, distressed and real estate) can be sold in the secondary
market. The transfer of the limited partnership interest typically will allow the investor to
receive some liquidity for the funded investments as well as a release from any remaining
unfunded obligations to the fund.

 Sale of Direct Interests – Secondary Directs or Synthetic secondaries, this category

refers to the sale of portfolios of direct investments in operating companies, rather than
limited partnership interests in investment funds. These portfolios historically have
originated from either corporate development programs or large financial institutions.

[edit] Private equity firms

Main articles: Private equity firm and List of private equity firms

According to an updated 2010 ranking created by industry magazine Private Equity

International[70] (published by PEI Media called the PEI 300), the largest private equity firm in
the world today is TPG, based on the amount of private equity direct-investment capital raised
over a five-year window. As ranked by the PEI 300, the 10 largest private equity firms in the
world are:

1. Goldman Sachs Principal Investment Area

2. The Carlyle Group
3. Kohlberg Kravis Roberts
4. TPG
5. Apollo Global Management
6. CVC Capital Partners
7. The Blackstone Group
8. Bain Capital
9. Warburg Pincus
10. Apax Partners

Because private equity firms are continuously in the process of raising, investing and distributing
their private equity funds, capital raised can often be the easiest to measure. Other metrics can
include the total value of companies purchased by a firm or an estimate of the size of a firm's
active portfolio plus capital available for new investments. As with any list that focuses on size,
the list does not provide any indication as to relative investment performance of these funds or
managers.

Additionally, Preqin (formerly known as Private Equity Intelligence), an independent data

provider, ranks the 25 largest private equity investment managers. Among the larger firms in that
ranking were AlpInvest Partners, AXA Private Equity, AIG Investments, Goldman Sachs Private
Equity Group and Pantheon Ventures. The European Private Equity and Venture Capital
Association ("EVCA") publishes a yearbook which analyses industry trends derived from data
disclosed by over 1, 300 European private equity funds.

[edit] Private equity funds

Main article: Private equity fund
This section needs additional citations for verification.
Please help improve this article by adding reliable references. Unsourced material may be challenged
and removed. (August 2009)

Private equity fundraising refers to the action of private equity firms seeking capital from
investors for their funds. Typically an investor will invest in a specific fund managed by a firm,
becoming a limited partner in the fund, rather than an investor in the firm itself. As a result, an
investor will only benefit from investments made by a firm where the investment is made from
the specific fund in which it has invested.

 Fund of funds. These are private equity funds that invest in other private equity funds in
order to provide investors with a lower risk product through exposure to a large number
of vehicles often of different type and regional focus. Fund of funds accounted for 14%
of global commitments made to private equity funds in 2006.
  Individuals with substantial net worth. Substantial net worth is often required of investors
by the law, since private equity funds are generally less regulated than ordinary mutual
funds. For example in the US, most funds require potential investors to qualify as
accredited investors, which requires $1 million of net worth, $200,000 of individual
income, or $300,000 of joint income (with spouse) for two documented years and an
expectation that such income level will continue.

As fundraising has grown over the past few years, so too has the number of investors in the
average fund. In 2004 there were 26 investors in the average private equity fund, this figure has
now grown to 42 according to Preqin ltd. (formerly known as Private Equity Intelligence).

The managers of private equity funds will also invest in their own vehicles, typically providing
between 1–5% of the overall capital.

Often private equity fund managers will employ the services of external fundraising teams
known as placement agents in order to raise capital for their vehicles. The use of placement
agents has grown over the past few years, with 40% of funds closed in 2006 employing their
services, according to Preqin ltd (formerly known as Private Equity Intelligence). Placement
agents will approach potential investors on behalf of the fund manager, and will typically take a
fee of around 1% of the commitments that they are able to garner.

The amount of time that a private equity firm spends raising capital varies depending on the level
of interest among investors, which is defined by current market conditions and also the track
record of previous funds raised by the firm in question. Firms can spend as little as one or two
months raising capital when they are able to reach the target that they set for their funds
relatively easily, often through gaining commitments from existing investors in their previous
funds, or where strong past performance leads to strong levels of investor interest. Other
managers may find fundraising taking considerably longer, with managers of less popular fund
types (such as US and European venture fund managers in the current climate) finding the
fundraising process more tough. It is not unheard of for funds to spend as long as two years on
the road seeking capital, although the majority of fund managers will complete fundraising
within nine months to fifteen months.

Once a fund has reached its fundraising target, it will have a final close. After this point it is not
normally possible for new investors to invest in the fund, unless they were to purchase an interest
in the fund on the secondary market.

[edit] Size of the industry – Investment activity

Over $90bn of private equity was invested globally in 2009, a significant fall from the $181bn
invested in the previous year. The 2009 total was more than 70% down on record levels seen in
2007. Deal making however gathered momentum during the year with larger deals announced
towards the end of 2009. With bank lending in short supply, the average cost of debt financing
was up and private equity firms were forced to contribute a bigger proportion of equity into their
deals.
Indicators for the first half of 2010 show that investment activity totalled $55bn with private
equity firms continuing to focus on investments in small and medium sized companies. The half-
year total was up slightly on the same period in 2009 but well down on the period between 2005
and 2008. Full year figures for 2010 may show a moderate increase on 2009 if the gradual
recovery in investments seen in recent months is sustained. Private-equity backed deals
generated 6.3% of global M&A volume in 2009, the lowest level in more than a decade and
down from the all-time high of 21% in 2006. This grew to 6.9% in the first half of 2010.

Regional breakdown of private equity activity shows that in 2009, North America accounted for
36% of private equity investments, up from 26% in the previous year while its share of funds
raised remained at around two-thirds of the total. Europe’s share of investments fell from 44% to
37% during the year. Its share of funds also declined, from 25% to 15%. While investments have
fallen in most regions in recent years, there has been a rise in the importance of Asia-Pacific and
emerging markets, particularly China, Singapore, South Korea and India. This is partly due to the
smaller impact of the economic crisis on this region and better prospects for economic growth.[71]

[edit] Size of the industry – Fundraising activity

Private equity funds under management totalled $2.5 trillion at the end of 2009 (Chart 3). Funds
available for investments totalled 40% of overall assets under management or some $1 trillion, a
result of high fund raising volumes between 2006 and 2008.[71]

Funds raised fell by two-thirds in 2009 to $150bn, the lowest annual amount raised since 2004.
The difficult fund raising conditions have continued into 2010 with half-yearly figures showing a
total of $70bn raised in the first six months, slightly below the same period in 2009. The average
time taken for funds to achieve a final close more than doubled between 2004 and 2010 to almost
20 months and in some cases the final amounts raised were below original targets. Prior to the
economic slowdown, the market saw intense competition for private equity financing. The three
years up to 2009 saw an unprecedented amount of activity, during which more than $1.4 trillion
in funds were raised.

[edit] Private equity fund performance

In the past the performance of private equity funds has been relatively difficult to track, as
private equity firms are under no obligation to publicly reveal the returns that they have achieved
from their investments. Private equity funds invest in privately held, owner-operated companies
looking to grow and are not listed on the public market, resulting in limited information to the
public.[72] In the majority of cases the only groups with knowledge of fund performance were
investors in the funds, academic institutes (as CEPRES Center of Private Equity Research) and
the firms themselves, making comparisons between various different firms, and the
establishment of market benchmarks to be a difficult challenge.

The application of the Freedom of Information Act (FOIA) in certain states in the United States
has made certain performance data more readily available. Specifically, FOIA has required
certain public agencies to disclose private equity performance data directly on the their websites.
[73]
In the United Kingdom, the second largest market for private equity, more data has become
available since the 2007 publication of the David Walker Guidelines for Disclosure and
Transparency in Private Equity.[74]

The performance of the private equity industry over the past few years differs between funds of
different types. Buyout and real estate funds have both performed strongly in the past few years
(i.e., from 2003–2007) in comparison with other asset classes such as public equities. In contrast
other fund investment types, venture capital most notably, have not shown similarly robust
performance.

Within each investment type, manager selection (i.e., identifying private equity firms capable of
generating above average performance) is a key determinant of an individual investor's
performance. Historically, performance of the top and bottom quartile managers has varied
dramatically and institutional investors conduct extensive due diligence in order to assess
prospective performance of a new private equity fund.

It is challenging to compare private equity performance to public equity performance, in

particular because private equity fund investments are drawn and returned over time as
investments are made and subsequently realized. One method, first published in 1994, is the
Long and Nickels Index Comparison Method (ICM). Another method which is gaining ground in
academia is the public market equivalent or profitability index. The profitability index
determines the investment in stock market investments required to earn a target profit from a
portfolio of private equity fund investments.[75] Driessen, et al. have recently pushlished a paper,
A New Method to Estimate Risk and Return of Non-Traded Assets from Cash Flows: The Case
of Private Equity Funds, on using Generalized Method of Moments estimators to simultaneously
solve for alpha and beta. The methodology relies on asymptotics, but it does allow the
calculation of risk adjusted returns, which have previously been unavailable or unreliable.

[edit] Recording private equity

There is a burgeoning debate of the purpose behind private equity, a common misconception to
treat private equity separately from foreign direct investment. The difference is blurred on
account of private equity not entering the country through the stock market. Private equity
generally flows to unlisted firms and to firms where the percentage of shares is relatively smaller
than the promoter or investor held shares (also known as free-floating shares)

The main point of contention behind differentiating private equity from FDI is that FDI is used
solely for production whereas in the case of private equity the investor can reclaim their money
after a revaluation period and make speculative investments in other financial assets.

Presently, most countries report private equity as a part of Foreign Direct Investment.[76]
Today :11.03.2010: redemption of the mutual funds. Need a letter of conformation regarding the
mutual funds.

Investment services online especially for mutual fund investing is also a major bonus for the bank as well
as the customers.

Fixed deposits: old age and fds also for tax saving which is one time investment.

Attending customer calls is also an important aspect. The personnel have to go to the clients place or
working place to get the financial instruments sold as per request or if the customer is very valuable n
generates that kind of business for the bank. This was in the case of the mutual funds: gold savings or to
give debit pins especially when they know that the customer iss going to invest in some important
ssecurities.
:

WEALTH MANAGEMENT IN INDIA:

According to a report the wealth management market in India will have a target size of 42 million households
by 2012, as against just about 13 million in 2007

New Delhi: Indians will have one trillion dollars worth investable wealth by 2012, with the country's robust economic
growth driving a four-fold surge from just about 250 billion dollars in 2007.

According to a report by international consultancy firm Celent, India is set to become a huge hunting ground for
wealth managers with the number of their potential clients and size of manageable wealth both expected to grow
four-times through 2012.

The wealth management market will have a target size of 42 million households by 2012, as against just about 13
million in 2007, noted the report titled 'Overview of the Wealth Management Market in India'.

"The wealth management sector is poised to witness tremendous growth. India's economic growth is making larger
sections of the population prospective customers of wealth management providers," Celent said.

The growth would be seen across all income-levels, but the lower-income segment would record the maximum
growth in terms of volume, while high-networth households would contribute the most in terms of wealth size, it noted.

Celent has defined a household with a minimum income of $5,000 (Rs2 lakh) as the lowest end of the target market
for wealth managers, while one with at least $30 million (Rs120 crore) of investable income has been put in the
category of ultra-high net worth.

The market would see different products being launched for catering to different client segments, Celent's banking
practice and author of the report Ravi Nawal said.

"There is an increasing momentum towards structure in this previously chaotic domain. We should expect some very
India specific innovations in the near future," Nawal added.

The market is currently dominated by unorganized players, whose share is 1.5 times that of the organized market.
However, a structural change is taking place and organized players are drawing clients away from the unorganized
players.

Wealth management revenues are expected to contribute 32-37% of the total revenue of full-service financial
institutions by 2012, Celent said.

According to the report, mass-market (Rs2-10 lakh of disposable income) would be a key driver, accounting for 40%
of the overall growth in the number of households.

A majority of wealth managers, except niche players, would target the mass market because of its youth-dominance
and this market would see more service providers entering the fray with a ‘own them young’ policy.

The ultra-high net worth households with wealth in excess of $30 million would have a total population of 10,500
households by 2012, while the super high net worth households ($10-30 million) are expected to grow to 42,000.

The population of high net worth households ($1-10 million) would grow to 3,20,000, while there would be 3,50,000
households in the super-affluent category (Rs50-400 lakh).

Besides, 10 lakh new households would join mass-affluent category (Rs10-50 lakh), taking their population to 18 lakh
by 2012. However, a vast majority of 39 million households, out of the total 42 million target market population in
2012, would belong to the mass market (Rs2-10 lakh).
Private banks, independent financial advisors and full service brokerages would serve the high networth segment,
while ultra high networth households would be served by private banks and family offices.