Hedge fund valuation methodology

May 04, 2020

by a searcher from London Business School in London, UK

Hi.
can anyone share some guidelines to valuing an alternative asset hedge fund, with partial AUM below the watermark and any adjustments that might be appropriate, such as overall business and operational health, investor stickiness, keyman risk, etc?

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Reply by a searcher
from University of Pennsylvania in Park City, UT, USA

If you're buying into the GP, I would just do a standard DCF where you're projecting what the 2 and 20 (or whatever their structure is) will look like going forward. Revenues are the 2 and 20, expenses are all the overhead (bloomberg, compliance, employee compensation, etc.). Overhead will be relatively fixed since the money management business is highly scalable (i.e., you can do the same thing with $10M as you can with $100M and not increase your costs at all). So what you're really betting on is the performance of the fund (the 20%) and how that will impact AUM (the 2%). Embedded in this is a bet on the overall performance of the market and whether you think they can outperform or underperform. Following that, how good are they at being able to attract capital to increase AUM?

Honestly, I worked at multi-strat hedge fund for a number of years and the idea of a manager selling a minority / majority share of the GP to an outsider is pretty rare. The money is just too lucrative and they typically keep it all to themselves - they RARELY give equity to members of the deal team. So a huge red flag / question I'd have is, why are you being presented with this opportunity?

Reply by a searcher
from Columbia University in Santa Monica, CA, USA

I previously worked for a single-manager value fund for a few years, and it kind of scares me to think about acquiring a stake in a hedge fund as an outside investor. There is a lot of key man risk, especially if it's a fund with one main portfolio manager, That PM is probably your biggest marketing asset, meaning a good chunk (if not most) of the AUM might walk out the door if they leave. Given this negotiating leverage they would have, these PMs would be quite expensive to employ. I would assume acquiring a minority or majority stake in the fund would also make it very hard to keep incentives aligned with the PM as well. As others have said, it's hard to envision a win-win scenario where you had the opportunity to purchase this stake when things weren't seriously wrong at the fund. I think I would personally much rather own an ETF!

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