Private equity and hedge funds: high returns or high risk?

The private equity illusion

Private equity funds typically show a J-curve: fees and deal costs hit early, while realisations come later. The first years can look like losses even if the eventual outcome is acceptable. Marketing decks start the story at the exit, not at the capital call.

Internal rate of return (IRR) is the industry’s favourite number. It is not the same as the cash you can spend. A promised 15% IRR can translate into a much lower annualised cash return once you account for delayed distributions, recycled capital and the years your money sat in uncalled commitments.

Valuations are often mark-to-model, not mark-to-market. Smoothing makes the path look calmer than listed equity. That calm is not the same as safety. Ask for the actual cash-on-cash history, net of fees, for the specific vintage — not a blended track record across funds you cannot buy.

Hedge fund fee structures explained

The classic “2 and 20” is a 2% annual management fee plus 20% of gains above a hurdle. On a year when the fund is flat, you still pay the 2%. On a year when it is up, you pay both. High-water marks are meant to stop the manager earning performance fees twice on the same recovery. Ask whether the mark resets, and on what schedule.

Lock-ups and redemption gates limit when you can leave. That is how the manager funds illiquid positions. It is also how you can be stuck after a bad year. After fees, many hedge-fund programmes have a hard time beating a cheap equity-and-bond mix over a full cycle. Some do. The burden of proof is on the audited numbers, not the pitch.

Liquidity mismatch risk

A fund that offers quarterly redemptions while holding assets it values once a year has a mismatch. In stress, gates close, side pockets isolate the unsellable names, and the liquid remaining investors fund the exit of others — or cannot exit at all.

The 2008 episode is the case study still worth teaching: redemption queues, suspended NAVs, and clients who discovered that “monthly liquidity” was a brochure term. If your own spending plan needs that capital on a known date, an alternative with a gate is the wrong sleeve.

Questions every client should ask

What is the actual historical net return for this vehicle, in francs, after every fee? May I see audited statements, not marketing slides? Who is the independent auditor, and how often do they sign? What happens to my holding if the manager fails, is acquired, or loses key people?

If those answers are slow, partial or replaced by a story about access and exclusivity, you already have a useful signal.