### Hedge Fund Bubble - Avenue Capital Selling to Morgan Stanley for $2 Billion

posted by MR WAVETHEORY at 10/13/2006 01:18:00 AMMorgan Stanley (NYSE MS) is reportedly buying 20% of Avenue Capital for $2 billion. That is a rich price to pay for a hedge fund. Avenue Capital has $12 billion in assets.

Put that into perspective, MWD is paying $1 for every $6 of assets. The price translates into 16% of the assets under management. I don't understand the logic. Someone, please explain to me what I am missing. Don't get me wrong, they are a great fund. But a typical fund earns 2% of assets plus 20% of the return.

To get to 16% return on equity, here's how the math has to look.

Target Return = 16%

Target Return = Fees + Performance

Assume,

Fee = 2% (Industry Standard)

Performance = 14% (20% of the Total Return)

Avenue has to earn 14% from performance. Since the typical fund gets 20% of the total return of assets, that implies Avenue has to generate 70% annualized returns on its $12 billion in assets to generate 16% return on equity. 70% returns are nearly impossible to achieve on an asset base of $12 billion.

Here's another way to look at it. Avenue has 210 employees, so Avenue Capital is being valued at $50 million per employee. Add to that, many of those employees are working in the backoffice, so the value of an investment professional is more than $50 million.

With the reputation of Morgan Stanley, is it that hard to raise $12 billion in assets? Is this a hedge fund bubble?

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