Which Creates More Wealth for General Partners: Private Equity Funds or Hedge Funds?

The perpetual question in the investment world is whether General Partners (GPs) in private equity (PE) funds or hedge funds earn more wealth. Understanding the dynamics of each investment strategy can provide insights into the true answer.

Private Equity Funds: An In-Depth Look

GPs in private equity funds often see greater wealth generation due to unique investment strategies and financial advantages. One key reason is the leverage employed in LBO (Leveraged Buyout) strategies, enabling PE funds to amplify their returns through borrowed capital.

PE funds typically use borrowed capital to invest in private companies or leverage the debt capital to acquire a public company, effectively reducing tax liabilities since companies can offset interest payments against their tax burdens. In contrast, hedge funds rely on equity capital, which does not allow such tax benefits. Moreover, PE funds often achieve higher rates of return since they pursue long-term investment strategies, as opposed to the short-term focus of hedge funds.

Hedge Funds: Scalability and Variability

The variability between specific firms is much greater than the differences between private equity and hedge fund asset classes in general. Given the lower barrier to entry and higher scalability of hedge funds, it is easier for a GP to achieve significant wealth, especially for those managing smaller funds (e.g., with less than $2 billion in assets under management (AUM)).

In some cases, hedge fund GPs can collect substantial incentive fees, equivalent to a "Brinks truck full of cash," particularly during high-performance years. However, these high returns are often the result of significant directional bets, making them less predictable and not a consistent strategy for long-term wealth creation. Additionally, due to daily marking-to-market, hedge funds face more direct investor pressure and can be more susceptible to short-term performance hiccups, which may lead to capital outflows and bankruptcy if not managed properly.

The Role of Performance and Structure

The age and longevity of the firms also play a significant role. A hedge fund with $2 billion in AUM and a 50% performance year can likely generate a large take-home payment without hurdles, incentives, or deferrals. Conversely, PE firms, while less scalable in the short term, offer locked-up capital, better long-term upside, and less exposure to market volatility.

In comparison, many of the successful hedge fund GPs tend to be younger, often because the demanding nature and shorter-term outlook of the industry can be too much for older professionals to handle. Meanwhile, in private equity, the long-term nature of the investments and the less frequent capital needs allow GPs from a wide age range to maintain their positions.

Conclusion

While both private equity and hedge funds can generate substantial wealth for GPs, the methods and outcomes often differ. Private equity funds generally allow for greater wealth creation through successful long-term investment strategies, whereas hedge funds provide opportunities for significant one-off returns but are more susceptible to short-term market pressures and liquidity issues.