The European “Premium” and the APAC “Discount”

Regional differences in business expenses emerge

Originally published in the January/February 2014 issue

While firms located in the US hold the majority of the hedge fund industry’s AUM, European firms are also strongly represented in the latest Citi Prime Finance Hedge Fund Business Expense survey, thereby enabling us to draw some interesting conclusions about the European industry relative to their US counterparts.

In its H1 2013 report on the location of industry assets, HFI put total assets managed out of the US at $1.66 trillion out of an industry total of $2.34 trillion (71%). Our 68 US survey respondents together had $288.0 billion AUM, 17% of the total US population. By comparison, HFI had assets managed out of Europe at $414 billion and the 35 participants in our survey collectively managed $168.5 billion, 41% of the European total.

One factor that stood out in examining this group of European participants was that their management company costs appeared to be higher than the same charges being realised by US firms. This is illustrated in Fig.1.

In four out of six of our size bands, there was a noticeable premium of at least 20% in terms of expenses being cited by European survey participants versus US firms. This was true for hedge funds with $100 million, $500 million, $5.0 billion and >$10.0 billion AUM. For those firms with between $1.5 and $10.0 billion AUM, the costs were within +/- 6% of each other – thus much more in line.

Delving into the numbers, one area stood out more than any other in terms of explaining the expense differences between the two regions: this was regarding expenses attributed to marketing. Unlike the US, where there is one contiguous market across which hedge funds are looking to raise capital, this is not the case in Europe. Instead, each country in that region is able to dictate its own private placement regime, and marketers must be able to understand and apply various sets of rules in looking to offer their product.

Fig.2 shows the variance between European and US firms in terms of marketing expenses realised by the management company. This includes compensation for marketing-related headcount as well as third-party expenses. Smaller hedge fund managers in Europe show the most variance in terms of their marketing spend, with $100 million AUM firms registering costs 200% greater and $500 million AUM firms continuing to show marketing expenses 152% higher. For smaller firms, much of that differential can be attributed to compensation.

In Europe, $100 million AUM firms spent 32 basis points on compensation for 1.07 heads, or the equivalent of $299,065 per head. This differs from the US, where total marketing compensation amounted to 10 basis points on 0.92 heads – the equivalent of $108,696 per head. This cost differential continued to be evident at $500 million AUM firms. European firms had an average compensation level of 7 basis points across their 1.32 heads ($265,151 per head) while US firms had spent an average of 4 basis points across 1.21 heads ($165,289 per head) on marketing compensation.

By the time these firms reached $5.0 billion AUM, the compensation differential narrowed, however, with the average compensation in Europe for marketing personnel rising to $545,898, and US counterparts rising to $528,247. Average compensation levels were also similar at the $10.0 billion AUM threshold ($631,500 in Europe versus $597,700 in the US). This shows that although the US adds its marketing personnel later in its development cycle, there is not as much of a compensation differential for larger firms, as both US and European firms look to have senior resources in these roles by the time they are into their institutional phase of development.

Differences in the number of marketing personnel account for much of the variance at higher AUM bands, however. European funds with $5.0 billion AUM had an average of 7.33 heads assigned to marketing versus 6.04 heads in the US. At $10.0 billion AUM the difference was even more pronounced, with European firms registering 20.5 heads versus only 6.6 heads in the US.

Fig.3 shows that, on average, marketing costs account for significantly more of the management company’s total expenses in Europe than in the US at nearly all major AUM levels.

The other area of expenditures where there was a noticeable European premium was operations and technology. The level of spend on these functions in Europe was larger than in the US, but by much smaller margins than were noted in marketing. This is illustrated in Fig.4.

The greatest differentials in operations and technology spend were at our lowest and highest levels of AUM: $100 million and greater than $10.0 billion. Firms in the mid-AUM range were more in line, falling within a -1% to +9% differential.

Small European firms with $100 million AUM registered expenses 30% higher than their US counterparts. The difference in operations and technology spend can be attributed to sharply higher third-party expenses. European firms of this size cited 40 basis points of third-party spend versus only 15 basis points for similarly sized US firms. Much of this difference can be attributed to data costs, as there is a substantially more fragmented set of markets to monitor in the European landscape.

The largest European firms with greater than $10.0 billion AUM also showed operations and technology costs that were 21% higher than their US competitors. This, however, was due to headcount. Total operations and technology headcount at the largest European firms averaged 135.2 heads versus only 73.7 heads in the US. As a result, compensation-related expenditures on operations and technology for these large European firms were 8 basis points versus only 4 basis points at similarly sized US hedge funds.

While noticeable, these differences are not nearly as great as those due to marketing costs. Fig.5 shows little differentiation in the pattern of spending on operations and technology between the two regions. Indeed, although the absolute basis point spend by European firms might have been higher in this category, the percentage of total management company spend is lower in Europe than for similarly sized US firms in nearly all instances.

The remaining management company costs reported by our European versus our US survey respondents showed a mixed bag. Risk and compliance and business management costs were higher at some AUM levels in Europe and lower in others. The same held true for business management.

On the whole, however, the pattern of European firms registering higher management company expenses (ex-investment management) proved out. The average management company spending for the 35 European firms was $15.8 million versus only $14.6 million across the 68 US firms in our sample. This equates to an overall premium of 8.0% in terms of costs.

The APAC “discount” for running a fund
The opposite pattern was evident in reviewing Asia/Pacific (APAC) funds in our dataset, where the management company expenses were consistently lower than for similarly sized US and European firms. Survey respondents from this region were confined to smaller-sized firms in the $100 million, $500 million and $1.5 billion AUM bands. We did not receive any results from APAC firms in the higher AUM bands; yet, in each instance, these APAC firms were being run at a substantial discount to similarly sized US and European firms.

Fig.6 shows the results for managers with $100 million AUM. Across our sample of managers at this size, the average management company expenses for US firms amounted to $1.92 million versus $2.18 million for European firms. The mean of these two figures was $2.04 million. This compares to $1.46 million in costs for APAC firms – a figure 28% below the mean.

To understand why costs for APAC funds were so much lower, we took the mean spend per category across our management company expenses and compared how much they varied across regions. The results of this analysis are highlighted in Fig.7.

As shown, there is very little differentiation in the amounts being spent across regions in terms of operations and technology, where expenditures by APAC funds with $100 million AUM were almost exactly on mean. Nor was there much difference in terms of risk and compliance, where the same pattern held true. A slightly more noticeable difference was registered on spend for business management, where APAC funds had expenses 13% below the mean.

Marketing was the area where the largest variation in spending between regions was registered. As already discussed, $100 million AUM European firms have extremely high marketing costs when compared to their US counterparts, but these costs were only slightly less pronounced when viewed against the APAC funds. In total, APAC funds spent $232,137 on marketing across personnel and third-party expenses on average versus $182,136 in the US and $549,587 in Europe. The size of the APAC discount grows, however, when firms with $500 million AUM are considered. This is shown in Fig.8.

As was previously the case, the total spend by firms in Europe was higher for managers at this size than for either the US or APAC. In the US, managers with $500 million AUM spent an average of $3.2 million for their management company expenses, excluding investment management costs. In Europe, the figure was substantially higher, at $4.4 million. The mean between these two regions was $3.8 million, a total that was 42% higher than the $2.2 million being spent in APAC.

Differences in headcount between the regions offer little explanation as to why it costs less in APAC. The average $500 million AUM APAC fund has 18.5 heads, of which 9.8 are focused outside investment management. This compares to a total of 15.8 heads in the US, 8.1 of which are outside investment management and to a total of 20.0 heads in Europe, 11.0 of which are focused outside investment management.

The average compensation being realised across these regions has much more to do with thecheaper APAC expense load. Across their investment support and business management headcount, $500 million AUM firms in APAC pay on average only $115,492 per person versus $224,287 in the US and $224,254 in emerging markets in Europe and Asia (EMEA).

Fig.9 shows that less expensive APAC headcount costs are impacting the overall level of spending in each major management company expense category outside investment management. As shown, costs in APAC are lower across the board than in other regions. The bulk of this is due to compensation.

In operations and technology, third-party expenses in APAC at 8 basis points are actually higher than in the US (5.3 basis points) and in EMEA (7.1 basis points). In risk and compliance, APAC and EMEA third-party expenses are on par at 1.0 and 0.9 basis points, respectively, lower than the 5.3 basis points in the US. A similar pattern holds true for business management, where APAC and Europe are on par (5.0 and 5.3 basis points, respectively) and US third-party expenses are higher, at 6.9 basis points.

The only area where APAC third-party expenditures are noticeably lower than in the other regions is marketing. For this function, APAC registers only 5.0 basis points of average cost compared to 17.2 basis points in EMEA and 6.2 basis points in the US

A very similar set of results is evident when we compare APAC funds with $1.5 billion AUM. This is shown in Fig.10.

US funds with $1.5 billion AUM spend $7.6 million on average on management company expenses outside of investment management. This compares to $8.4 million for EMEA funds. The mean between those two sets of firms is $8.0 million. This compares to total expenditures outside investment management of only $4.9 million in APAC – a figure 39% lower than the mean.

As was previously the case, firms with $1.5 billion AUM in APAC have total headcount that lines up closely with similarly sized European firms. APAC hedge funds have 42.7 total headcount, of which 23.0 are focused outside investment management. European firms have 43.4 headcount, of which 28.6 work in investment support and business management. US firms continue to operate with fewer resources. In total, US firms have 32.8 heads, of which 18.9 are focused outside investment management.

Average compensation per head for investment support and business management roles also continues to lag in APAC. On a per-head basis, our model showed that APAC hedge funds were only paying $129,320 versus $189,557 in EMEA. In the US, there is a sharp jump in average compensation that takes place at the $1.5 billion AUM mark; this is where many organisations begin to hire professional operations and investor relations teams. This boosts their average per-head compensation expense to $316,495.

APAC firms with $1.5 billion AUM also pay much less in third-party expenses than their peers in other regions. Our model shows these firms registering a total third-party spend of 10.8 basis points. This is lower than in the US, where the total is 12.7 basis points and substantially less than for EMEA firms, where the figure was 20.9 basis points.