Chart Of The Day – Operating Margins Across Hedge Fund AUM Range

By Hedge Fund Insight staff

Today’s Chart Of The Day comes from the Citi Prime Finance 2013 Business Expense Benchmark Survey released this week. We have known for some time that the balance of supply and demand post 2009 has been such that it has meant that hedge funds, even very well known and large ones, have had to agree better terms with investors than 2 and 20. Database studies show that annual management charges across all sizes of hedge fund average around 160 basis points. So the contribution of management fees to the revenue side of the operating profit margin is consistent across all funds. The cost side is not, as reflected in the operating margin graphic below.


Operating Margins Based on Average Management Company Fees & Expenses (by Fund Size)


source: Citi Prime Finance

Several important regional differences were shown in the data. European hedge funds were more expensive to operate than American ones, and Asian hedge fund management companies were cheaper.

The majority of European hedge funds responding to the survey had higher management company expenses than similarly sized U.S. hedge funds. In 4 out of the 6 examined AUM bands, European management company expenses were at least 20% higher than U.S. costs. Marketing was the single largest category of expense variance between the U.S. and Europe. For smaller hedge funds with $100 million to $500 million AUM, European marketing expenses were 150% to 200% higher than in the U.S., due mostly to compensation differentials. In addition, European funds hired more senior marketing personnel early in their development cycle.

Asian hedge funds showed the opposite pattern. Survey respondents from Asia were confined to the lower AUM bands in the Citi analysis,  $100 million, $500 million and $1.5 billion AUM. At each of these levels, average management company expenses were lower than in both the U.S. and Europe. $100 million AUM Asian-Pacific (APAC) hedge funds had average management company expenses 20%
lower than the mean costs noted in the U.S. and Europe for similarly sized firms. This differential expanded at $500 million AUM, with APAC funds registering expenses 42% below the mean and staying heavily discounted at 39% under the mean for firms at $1.5 billion AUM.

From a headcount perspective, APAC hedge funds were nearly on par with European hedge funds, but the total basis points being spent on compensation were significantly lower—by 38% for $100 million AUM funds, by 54% for $500 million AUM funds and by 32% for $1.5 billion AUM funds. Third party expenses for the management company were also significantly lower by a differential of 27 basis points,
13 basis points and 10 basis points respectively.

Based on survey responses, Citi estimate that hedge fund managers need at least $300 million AUM to break even. Firms with lower amounts of AUM will not be able to cover their management company costs without additional capital or incentive fee payouts. These management company costs include third party expenses, salaries for the investment team and total compensation for investment support and business management personnel.

At the opposite end of the scale, franchise firms (running more than $10bn AUM) have better margins than smaller hedge fund management groups partly because they find it easier to offer meaningfully sized long-only products.  It could be seen that management costs are covered by long-only management fees allowing more of the fuller hedge fund fee to come through to the profit margin. At the level of franchise firm typically nearly half the AUM are long-only.