If you’re trying to get onto the buyside, one of the first career forks you’ll be presented with is whether to pursue private equity or whether to pursue hedge funds. As buyside firms become increasingly tenacious, you might have to make this decision within the first 3-6 months of graduating from college.
Most people (including myself) figured that we would have enough time to research different roles, get relevant work experience, and organically speak with people to learn about private equity and hedge funds. But in truth, the recruiting process begins so quickly that if you’re in banking or consulting, you’ll be forced to make this decision before you know it.
There are of course many other lucrative career paths you could go down in finance (venture capital, credit, infrastructure, etc.), but I find that the majority of investment banking analysts choose between private equity and hedge funds. This tends to be even truer on the east coast, where there’s a huge supply of hedge funds and people are more laser focused on finance opportunities.
To summarize this entire post, my recommendation is generally as follows: if you want a safe outcome, optionality or to go to business school, do private equity. If you’ve always liked stocks, like talking about finance outside of work, and want the opportunity to make more money, do hedge funds.
If you're interested in pursuing private equity, you can check out our Private Equity Recruiting Course to learn how to build an LBO, do a case study, and answer technical questions asked by interviewers.
Buyside Career Paths
Private equity and hedge funds are perhaps the two most opaque and lucrative careers in the entire business world. If you join one of the best firms (i.e. one of the top-performing funds) and continue to rise in the ranks, it’s not unreasonable to think you’ll be earning in excess of a million dollars by the time you’re in your early 30s. It really pays to be really good at capital management. Working at a mega fund can mean that you'll be earning huge amounts of management fees.
On the surface, private equity and hedge funds can seem like very similar professions.
In both fields, you’ll:
Study businesses and learn how economic systems work
Build financial models
Meet with management teams
Manage investments in order to generate money for your investors
There’s a great amount of overlap, which is why candidates often have difficulty deciding between them. However, there are also big differences that will have a profound impact on your career, earning potential, and day-to-day work experience.
Let’s go over the key characteristics of each field.
Key Characteristics of Private Equity
Buy companies and improve them
In private equity, you buy private companies in order to improve their financials and operations. You’re typically buying whole companies or large enough stakes where you can have major influence over the direction of the business. Private equity is a lot more about control and taking over an entire business.
As such, a private equity firm is going to generally have a fewer number of investments to watch over than a hedge fund. Many private equity firms will have maybe 10-20 companies in their portfolio at a given time. This puts a very, very strong emphasis on granular due diligence because you have a fewer number of bets to get right. Additionally, because you’re purchasing whole companies (as opposed to stock), most transactions are completed in the context of deals. You have to go through processes in order to purchase companies in private equity.
Hold investments for years
By virtue of purchasing entire companies, you’ll also be stuck with companies for the long haul in private equity. The average hold time of a company in private equity is about 6 years (which is probably longer than the average career of someone who enters private equity).
When you purchase companies, it can take years for them to grow and improve their operations. Private equity is also built around the concept of severely burdening a company with debt, and it can take several years to pay down that debt.
Private equity tends to be a big game of patience. You look at a high volume of potential opportunities, but you can only invest in a few. Then you hold those investments for a long time.
Use debt to target 20%+ returns
A big puzzle piece of the private equity business model is a sacrosanct use of debt. When you buy a company, you can control what goes on its balance sheet. So you can effectively load with a ton of debt. This is good for you (most of the time), because you can use that debt to lower how much equity you need to put up initially. This allows private equity firms to purchase larger companies and gain outsized returns on the money they put up.
The use of leverage essentially increases your potential returns. Most private equity firms target a 20%+ annual return.
Exposure to multiple faculties
I think one of the most enticing factors of private equity to junior folks is the optionality of the career paths. In private equity, you get to look at businesses under an investing lens, but the nature of the private equity model also exposes you to functions like legal, corporate development, FP&A and operations.
If you end up becoming a private equity associate, you’ll have a straight shot to the top business schools and top hedge funds, while still leaving the door open to VC, corporate development, and start-ups. As with investment banking, you learn a little bit of everything.
Key Characteristics of Hedge Funds
Look, there are so many different kinds of hedge funds. The term “hedge fund” is a really imprecise label.
Here, I’m going to be speaking about fundamental equity hedge funds, because that’s what most investment bankers and consultants end up doing. “Fundamental” implies that you’re analyzing the business, the economy, and the business’ financials (as opposed to quantitative). Some hedge fund types in this category would include long / short equity, long-only, event-driven, and activist funds. We’re excluding things like quant, algorithmic trading, and derivative funds, which tend to be more suited for traditional STEM types.
Invest in public stocks
Instead of buying whole companies on the private market, these fundamental equity hedge funds buy public stocks. They typically buy shares of common equity in these companies. The key difference here has to do with liquidity – you can very easily trade in and out of stocks. You can make a trade in a matter of seconds at a hedge fund, while private equity processes can take weeks (or months).
Public stocks are also marked to market, meaning that their value is transparently available every single day. I think people at hedge funds tend to have a slightly greater psychological burden when it comes to investing because your performance is explicit to you and your boss. This can be very positive if you’re someone who is motivated by clear metrics.
Able to short companies to hedge risk
The long / short model employs the use of “shorting” in order to hedge their own risk on trades or further amplify returns. There’s no explicit mechanism to short a private company in private equity, but you can easily short a public stock.
Hedge funds have the option of going both long and short positions, which can lead to a lot of different investing strategies. Many funds are “net long”, where you invest in companies you believe in and short companies you think will fail, giving you a potentially higher upside. There are also “market neutral” funds, which try to pair long and short trades in order to mitigate market risk.
Try to beat a benchmark
Most hedge funds are given a benchmark to beat and will at least partially be compensated on their relative performance to the benchmark. A lot of the times this will be the S&P 500 (a composite index of the world’s biggest stocks). There’s less of a standard target return threshold than in private equity because there are many different kinds of investors. “Market neutral” funds try to always yield positive results, even if at the cost of losing out on higher highs.
Highly specialized skillset
Those who go down the hedge fund path are often sacrificing a little bit of optionality (relative to private equity). The job is laser focused on analyzing public companies. You spend a lot of your time building models, analyzing a company’s financials, and creating a bulletproof investment thesis. You’re investing in common equity, so there’s less legal work.
You’re not always going to be taking a controlling stake, so you won’t be as involved with corporate development, FP&A, or other parts of the business.
Most people who enter the hedge fund world tend to stay in it or in a highly related sphere. There are fewer people who go to hedge funds that switch to PE, VC, or corporate. I think hedge funds tend to have fewer institutional relationships with big companies and business schools. Many top hedge funds are extremely lean and focused firms, while many top private equity firms try to maximize the amount of assets they manage.
Private Equity vs. Hedge Funds
Below is a table capturing some of the discrete career factors of the most junior roles in both careers. We are referring to the position you will have as a mid-20s person (i.e. right after being a banking analyst).
Private equity associate positions tend to pay in a relatively narrow band. It’s somewhat standardized across the industry that you’ll be getting between $250k to $400k at a mid-market to mega fund.
Hedge fund salary is extremely contingent on how well your fund is doing. If you were down on the year, you might just make your base ($150k), but if you’re at a top performing fund, you could make close to a million dollars as a mid-20s professional.
Private equity requires doing deals so you’ll probably generally be working in private equity more. Doing process-oriented transactions has a requisite amount of work that is extremely high.
Hedge fund hours can become busier during earnings season (once per quarter). You also have to go in earlier (like around 7:30 to 8:00 am) so you can match market hours.
The nature of private equity capital is pretty stable. Capital is locked for years because the investing strategy is based on holding companies for the longer term. You have to screw up several funds in private equity in order to have a chance of shut down. This can make a career in private equity relatively more stable.
Hedge funds are extremely susceptible to redemptions. By virtue of being marked to market, your investors will know exactly how well you are doing. There tend to be fewer barriers for investors to redeem their money. So if you’re at a newer fund that has a few rough quarters, it’s not inconceivable that your fund could shut down.
Again, both careers are extremely coveted and you’d be fortunate to land a job in either. I’ll reiterate the advice I give to people who are trying to decide:
Go into private equity if:
You want to preserve optionality.
You want to go to business school.
You are on the risk-averse side.
Go into hedge funds if:
You’ve always really liked finance (have an active PA, constantly read about stocks and read finance-related books for leisure).
You don’t mind some volatility (or you’re super smart so you’ll crush the competition).
You want the opportunity to make more money.