PRINT THIS PAGE Private equity and hedge funds: a meeting of giants06/12/2006. Source: Association for Corporate Growth (ACG); Grant Thornton. 
There's a blurring of the line between private equity and hedge funds, driven primarily by hedge funds seeking higher returns, says the ACG and Grant Thornton, as well as more capital to manage and diversification of risk. “The convergence trend is driven by hedge funds looking for ways to put their growing assets to work across a wider spectrum of financial opportunities, boost returns, and diversify their risks, and private equity firms seeking ways to attract more capital and realize gains on a more current basis, rather than waiting for portfolios to mature,” said Daniel A. Varroney, ACG President & CEO, speaking about the results of their convergence survey. “The effect is more options for buyers and sellers of businesses, and additional partners to co-invest with, but also greater competition and higher prices for acquisitions, which could have a negative effect on returns.”
Convergence Takes Hold
There is a consensus among the hedge fund and private equity professionals polled that convergence has taken hold. In fact, only 5% of private equity respondents and 6% of hedge fund managers said “there is no significant overlap.” Most respondents believe that for now, it is affecting primarily the largest private equity and hedge funds, according to 41% of private equity, and 52% of hedge funds respondents. They believe convergence will continue to grow, according to 46% of private equity and 52% of hedge fund professionals.
“Companies seeking funding will likely benefit from the vast amounts of capital available from an increasingly wide range of sources,” said Harris Smith, West Region Managing Partner, Grant Thornton LLP, and author of a whitepaper on this subject. “At the same time, a number of significant challenges may stifle convergence beyond the very largest hedge funds and private equity firms.”
Hedge Funds Driving Trend
Private equity professionals point to hedge funds as the drivers of this trend (83%), and hedge funds concur, with 52% saying hedge funds are behind the convergence, and only 3% saying it is a private-equity driven phenomenon. While 39% of private equity respondents say the trend is having an effect on private equity investing, only 23% of hedge funds say the effect is affecting their industry.
Hedge funds say they are getting involved in private equity for several reasons, to: boost returns (61%); attract more capital (45%); diversify risk (45%); and receive bigger paychecks (26%).
Private equity firms say they’re getting involved in hedge funds to: attract more capital (58%); receive bigger paychecks (39%); boost returns (30%); and diversify risk (30%).
Of the private equity firms surveyed, 58% say they would never get involved in hedge fund investing, while 26% have discussed getting involved in hedge funds, only 2% have plans to do so. For hedge funds, while 33% say they would never get involved in private equity, 40% have discussed the option.
Effects of Convergence
Convergence is creating more options for buyers and seller, say 66% of private equity firms and 42% of hedge funds, and is presenting additional partners to co-invest with, say 49% of private equity firms and 45% of hedge funds.
However, a clear effect of this overlap is greater competition and higher prices for acquisitions, according to 84% of private equity respondents and 45% of hedge funds, as well greater competition for Limited Partners’ capital, say 43% of private equity and 32% of hedge funds.
Fifty-eight percent of private equity pros and 39% of hedge funds say hedge funds are aiming for quicker liquidity events in their private equity investments. However, they will have to impose longer lock-up periods, say 33% of private equity firms and 68% of hedge funds. Private equity firms who get involved in hedge fund investing will take a longer-term approach than most hedge funds, according to 57% of hedge funds and 32% of private equity pros.
Private equity firms largely don’t think it makes sense for most of their peers to get involved in the hedge fund world, with 55% saying it doesn’t make sense for any private equity firm, and 30% saying it makes sense for the biggest buyout firms. Hedge funds feel largely the same way about private equity involvement in their territory, with 40% saying it doesn’t make sense for any private equity firms, and 40% saying it does for the largest buyout firms.
Returns May Suffer
While 91% of private equity professionals and 87% of hedge funds say hedge funds will increasingly invest in private companies, 68% of private equity firms and 42% of hedge funds say hedge funds’ private equity investment returns will be worse than private equity firms. Likewise, 57% of private equity firms and 44% of hedge funds say private equity firms’ hedge fund returns will be worse than most hedge funds.
Industry Statistics
As the public equity markets struggle through another lackluster year, record numbers of institutional investors are seeking the higher yields private equity funds and hedge funds can generate. According to Buyouts Magazine, there were 267 buyout and mezzanine funds being raised in the first half of the year, which together amassed $82.87 billion in new commitments. Last year, U.S. buyout funds raised a record-breaking $173.5 billion, according to Buyouts Magazine data.
This brings the total U.S. private equity capital under management by 1,546 U.S. private equity firms to $811.20 billion as of June 30, 2006, according to Thomson Financial. Worldwide, there are approximately 3,000 private equity funds managing $1.5 trillion, according to Freeman & Co. At the same time, MARHedge reports that 8,800 hedge funds are now managing some $1.2 trillion in assets worldwide, with approximately 60 percent in the U.S.
This survey of 123 hedge fund and private equity professionals took place in June 2006. It was conducted through the auspices of ACG and MARHedge, a news service which serves the hedge fund industry. ACG polled its member private equity firms, and MARHedge polled hedge funds that subscribe to its news services.
Founded in 1954, the Association for Corporate Growth (ACG) is a global association for professionals involved in corporate growth, corporate development, and mergers and acquisitions.
Grant Thornton LLP is the U.S. member firm of Grant Thornton International, one of the six global accounting, tax and business advisory organizations.
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