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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   1

Hedged in: An inflow of new funds will boost revenue, but higher regulations may limit growth

IBISWorld Industry Report 52599

Private Equity, Hedge Funds & Investment Vehicles in the US
October 2013 Caitlin Newsom
2 About this Industry
2 2 2 2 Industry Definition Main Activities Similar Industries Additional Resources 17 International Trade 18 Business Locations

32 Key Statistics
32 Industry Data 32 Annual Change 32 Key Ratios

20 Competitive Landscape
20 Market Share Concentration 20 Key Success Factors

33 Jargon & Glossary

3 Industry at a Glance 4 Industry Performance
4 4 6 8 Executive Summary Key External Drivers Current Performance Industry Outlook

20 Cost Structure Benchmarks 22 Basis of Competition 23 Barriers to Entry 24 Industry Globalization

25 Major Companies 28 Operating Conditions
28 Capital Intensity 29 Technology & Systems 29 Revenue Volatility 30 Regulation & Policy 31 Industry Assistance

11 Industry Life Cycle

13 Products & Markets
13 Supply Chain 13 Products & Services 15 Demand Determinants 16 Major Markets

www.ibisworld.com | 1-800-330-3772 | info @ibisworld.com

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   2

About this Industry
Industry Definition
This industry comprises a range of alternative investment vehicles including private equity, hedge funds, closed-end funds and structured investment funds. Entities in this industry pool include investments, securities or other assets on behalf of shareholders, unit holders or other beneficiaries to achieve high returns on targeted investments. This industry does not include mutual funds, real estate investment trusts or exchangetraded funds.

Main Activities

The primary activities of this industry are Hedge funds Private equity funds Closed-end mutual funds Profit-sharing funds Unit investment trust funds Special purpose vehicles investing in collateralized mortgage obligations Mortgage real estate investment trusts

The major products and services in this industry are Closed-end funds and unit investment trusts Hedge funds Private equity funds Structured investment vehicles

Similar Industries

52512 Health & Welfare Funds in the US Fund plans and programs that provide medical and other health and welfare-related employee benefits. 52591 Open-End Investment Funds in the US Mutual funds organized to pool assets that consist of securities or other financial instruments. 52592 Trusts & Estates in the US Includes trusts, agency accounts or estates administered on behalf of the beneficiaries. 52593 Real Estate Investment Trusts in the US Real estate investment trusts investing in a range of real estate assets.

Additional Resources

For additional information on this industry www.aima.org Alternative Investment Management Association www.privateequity.com PrivateEquity.com www.sifma.org Securities Industry and Financial Markets Association

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Private Equity, Hedge Funds & Investment Vehicles in the US October 2013  

3

Industry at a Glance
Private Equity, Hedge Funds & Investment Vehicles in 2013 Key Statistics Snapshot
Revenue

$89.2bn 6.5%
Profit Wages
Revenue vs. employment growth
30 20

3.8% $29.4bn $18.4bn 11,098
Businesses
300 150

Annual Growth 08-13

Annual Growth 13-18

Market Share

Demand from retirement and pension plans

There are no Major Players in this industry
% change

0 −10 −20

% change

10

0 −150 −300 −450

Year 05 Revenue
p. 25

−30

07

09

11

13

15

17

19

Year

−600

07

09

11

13

15

17

19

Employment
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Products and services segmentation (2013)
Closed-end funds and unit investment trusts

Key External Drivers
Investor uncertainty S&P 500 Access to credit Yield on 10-year Treasury note

3%

Demand from retirement and pension plans

Structured investment vehicles

1%

Regulation for the Investment Management industries

Hedge funds

40%

Private equity funds

56%

p. 4
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Industry Structure

Life Cycle Stage Revenue Volatility Capital Intensity Industry Assistance Concentration Level

Mature High Low None Low

Regulation Level Technology Change Barriers to Entry Industry Globalization Competition Level

Medium Medium Medium High High

FOR ADDITIONAL STATISTICS AND TIME SERIES SEE THE APPENDIX ON PAGE 32

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   4

Industry Performance
Executive Summary
The Private Equity, Hedge Funds and Investment Vehicles industry continues to become an increasingly integral part of institutional investor portfolios and a mainstream part of the asset management market. The industry was once limited to high net-worth individuals and large institutional investors. However, increasing demand from institutional investors has contributed to the surge in industry assets under management (AUM) and revenue over the past five years. To a lesser extent, growth is also attributed to

Executive Summary   |   Key External Drivers   |   Current Performance Industry Outlook   |   Life Cycle Stage
reduce volatility and risk. Industry AUM increased at a 7.2% annualized rate during this period to about $4.1 trillion in 2013, underpinned by significant new inflows of capital into industry funds and rising asset values. However, this growth comes off a 25.2% drop in revenue in 2008 at the height of the global financial crisis and subsequent recession. Revenue quickly rebounded as a result of new capital inflows and higher returns due to improving economic conditions. In 2013, IBISWorld expects industry revenue to increase 1.4% as investors continue to seek the attractive returns offered by private equity funds and hedge funds relative to other asset classes in an otherwise low-return environment. Over the five years to 2018, IBISWorld estimates industry revenue will increase at an annualized rate of 3.8% to about $107.7 billion. Institutional investors will continue to increase their investments in alternative asset classes, while greater retail access to these same asset classes and strategies through ETFs and mutual funds will further increase industry AUM and revenue. Growth in global capital markets and a cyclical upswing in the private equity market will also support revenue increases. At the same time, revenue will likely be tempered by new regulations and a higher tax burden that will raise industry compliance costs.

Increasing  

demand from institutional investors has boosted assets under management
the high profile initial public offerings (IPOs) of leading alternative asset management firms and greater retail investor accessibility to alternative assets and strategies through exchange-traded funds (ETFs) and mutual funds. In the five years to 2013, industry revenue grew at an estimated 6.5% average annual rate to $89.2 billion. The primary driver of growth was increasing institutional investor demand for exposure to alternative asset classes. This exposure was aimed at achieving higher returns uncorrelated to broader equity markets and diversifying portfolios to

Key External Drivers

Demand from retirement and pension plans Institutional investors, such as retirement and pension plans, are the largest contributors to alternative investment vehicles like private equity funds and hedge funds due to their low liquidity needs and high-risk tolerances. Higher upstream demand, i.e. levels of investment, from these investors boosts industry revenue through asset

management fees. Demand from retirement and pension plans is expected to increase in 2013. Investor uncertainty The level of investor uncertainty is generally inversely correlated to the level of investment in private equity, hedge funds and other investment vehicles. When investor uncertainty falls, investors generally commit more assets to

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   5

Industry Performance

Key External Drivers continued

alternative investment funds and private equity deal-making improves. Investor uncertainty is expected to decrease over 2013, which will benefit the industry. S&P 500 The Standard & Poor’s 500 stock index (S&P 500) is among the most commonly cited indicators of stock market performance. When the stock market is performing strongly, the value of AUM in private equity, hedge funds and other investment vehicles rises along with their investment returns. As a result, both their level of assets under management and the asset and performance fees that they earn increases, which drives up industry revenue. The S&P 500 is expected to rise over 2013. Access to credit Favorable access to credit is an important driver of private equity and hedge fund performance. Private equity firms generally finance a significant amount of their investments and deal with debt, while hedge funds borrow capital from prime brokers to take larger investment positions and achieve higher returns. Restricted access to credit, such as during recessionary economic conditions, hampers private equity deal activity and reduces hedge fund returns, which decreases industry revenue
Demand from retirement and pension plans
300 150

and hurts industry profitability. Access to credit is expected to improve in 2013, presenting the industry with a potential opportunity for growth. Yield on 10-year Treasury note The yield on 10-year Treasury notes is an indicator of the general level of interest rates, which set the cost of borrowing in the United States. Higher interest rate levels negatively affect private equity deal making, the valuation of financial securities and stock market performance. Higher interest rate levels also raise the rate of returns generated on substitute investments to private equity funds, hedge funds and other investment vehicles such as stocks, bonds and savings investment vehicles. Interest rates are expected to increase in 2013 but still remain below the historical average. Regulation for the Investment Management industries An increase in the regulation and taxation of private equity, hedge funds or other investment vehicles may raise their compliance costs, reduce their returns and limit the number of investment activities companies can undertake. Industry regulation is expected to increase over 2013, presenting a potential threat to industry growth.
S&P 500
2400 2000

% change

0

Index

−150 −300 −450

1600 1200 800

Year

−600

07

09

11

13

15

17

19

Year 04

06

08

10

12

14

16

18

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   6

Industry Performance

Current Performance

The Private Equity, Hedge Funds and Investment Vehicles industry is quickly becoming a mainstream part of the larger asset management market. It is comprised of a wide range of complex investment vehicles such as hedge funds, private equity funds, closed-end funds and structured investment funds that employ various investment strategies and invest in a diverse number of asset

classes. These asset classes include traditional assets, like stocks and bonds and nontraditional assets, such as derivative securities, asset- and mortgage-backed securities and distressed debt. Revenue largely depends on performance fees tied to the funds’ capital gains and varies widely between funds, but revenue also includes assetbased management fees.

Increasing institutional investor demand

Over the five years to 2013, IBISWorld estimates that industry revenue grew at a 6.5% average annual rate to $89.2 billion. However, this growth is off a recessionary low base; the 2008 financial crisis and subsequent recession triggered large drops in asset prices and unprecedented investment losses, causing industry revenue to plunge 25.2% in 2008. Revenue has been rebounding since 2009, primarily due to the increasing institutional investor demand for exposure to alternative asset classes to achieve higher returns and diversify their portfolios, thus reducing volatility and risk. Industry assets under management (AUM) increased at an annualized rate of 7.2% during this period to about $4.1 trillion in 2013, underpinned by significant new inflows of capital into industry funds and rising asset values. Capital inflows were further supported by a number of long-term trends, including the growth in pension funds due to the increasing age and wealth of populations in developed countries. In turn, the increasing amount of AUM boosted revenue through asset-based

Industry revenue
30 20

% change

10 0 −10 −20

Year 05

−30

07

09

11

13

15

17

19

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management fees. The S&P 500 index, a broad indicator of overall asset prices, also rose at an average annual rate of 5.7% over the five years to 2013, supporting industry revenue growth. In 2013, IBISWorld expects industry revenue to increase 1.4% as strong capital inflows are tempered by increased regulations, heightened taxation and compliance costs, which hurt industry fundraising, investment returns and financial performance.

Industry landscape and profit

Like the rest of the asset management sector, the industry landscape is highly dynamic, competitive and fragmented. Low barriers to entry and constantly changing preferences of institutional

investors keep industry concentration low. IBISWorld estimates there are about 11,098 US-based funds in the industry in 2013. Over the past five years, the number of industry funds

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Industry Performance

Industry landscape and profit continued

declined at an annualized rate of 0.6%, due to significant hedge fund and unit fund closures. The number of US private equity funds grew at a modest annualized rate of 2.0% over the past five years despite losses at several leading private equity firms during the recession and rising pressure from new market entrants. Industry profit has rebounded from recessionary lows over the past five years, but still remains below prerecessionary levels. IBISWorld estimates the average industry profit margin across all investment vehicles is

about 33.0% in 2013, up from 28.0% in 2008; however, this still remains below peak 2007 levels of about 40.0%. Industry operators reduced the number of employees in order to offset the declines in profit. Over the past five years, employment fell at an annualized rate of 0.9% to 71,931 workers. Additionally, improvements in financial markets and private equity deal flow since the recession have helped profit margins gradually improve over the past five years, while new regulatory compliance costs and tax burdens have partially offset some of these gains.

Hedge funds

Hedge funds pool investors’ capital and invest these funds in various traditional and nontraditional asset classes. In order to earn more money than traditional market returns, they pursue leveraging and other speculative investment practices that magnify investment gains and losses. Hedge funds are a growing force in financial markets. Although hedge funds represent just 5.0% of all US AUM, they accounted for about 30.0% of all US equity trading volume in 2011, according to Securities and Exchange Commission (SEC) estimates. Hedge fund AUM has made a strong recovery from the recession, increasing at a 9.8% annualized rate over the five years to 2013. Hedge fund closures skyrocketed in 2008 as the subprime crisis submerged the industry. Hedge funds exposed to structured debt products generated negative investment returns due to write-downs (declines in debt product values). Hedge fund AUM further declined as investors withdrew their

The  

number of industry funds declined due to hedge fund and unit fund closures
money from funds. The value of US hedge funds’ AUM fell 24.7% in 2008 to $1.5 trillion. While hedge funds were among the first to feel the impact of the subprime crisis, they have also been among the first to recuperate, starting in 2009. Hedge fund AUM and revenue grew through 2013, although volatile markets made growth uneven from year to year. Much of this recovery is due to an appreciation in the value of existing assets, in line with the improvement in global stock markets. Additionally, since mid-2009, new investment in hedge funds has exceeded fund redemptions, leading to a small rise in net capital inflows.

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Industry Performance

Private equity

Private equity firms pool private wealthy investor funds for investment in private company equity. They derive revenue from management or asset-based fees and a performance fee on total deal value upon exiting a company. However, fees vary among firms and depend on deal terms; management fees average 2.0% and performance fees average 20.0%. Over the five years to 2013, US private equity revenue fell at an average annual rate of 1.0% to $144.0 billion, largely due to the downturn in deal volume caused by the recession. Private equity revenue fell 43.2% in 2008 and 3.3% in 2009 during the recession. However, revenue has rebounded since 2010 due to increased mergers and acquisitions. On the supply side, rebounding valuations and strong corporate debt markets have brought more attractive assets (companies) for sale into the market. On the demand side, private equity firms sitting on nearly $1.0 trillion in uninvested client assets have been under mounting pressure to make acquisitions before investment periods expire. Increased

Private  

equity firms are under pressure to make acquisitions before investment periods expire
business activity drove revenue increases in 2012 and is expected to continue driving revenue growth over 2013. However, investors remain cautiously optimistic. IBISWorld projects other trends stemming from the 2008 subprime crisis will make this cycle different from the past, which was characterized by deals that involved taking public companies private. Since the recession, private equity firms limited their investments to industries uncorrelated to markets, focusing specifically on add-on companies to strengthen their portfolio companies. Large firms have also put pressure on mid-size private equity firms by moving down market and pursuing more deals in the $15.0 million to $500.0 million range.

Industry Outlook

Over the five years to 2018, IBISWorld estimates revenue will grow an average 3.8% annually to $107.7 billion due to an expected rise in stock markets, continuing growing demand from institutional investors and the cyclical upswing in the private equity market. In 2014, rebounding capital markets, asset valuations and alternative asset demand will drive revenue up 3.8% to $92.6 billion. Federal Reserve policies are expected to keep interest rates low through 2015, making hedge funds and private equity funds attractive to investors in an otherwise low-return environment. However, new legislation, forecast increases in interest rates, rising competition and the continued deleveraging of investments will temper

revenue growth over the next five years. Industry profit is expected to grow slowly through 2018 as competition and consolidation lead to downward pressure on industry fees and profitability. Investment funds are projected to decline at an average annual rate of 1.1% to about 10,510 in the five years to 2018 as mergers and acquisitions in the industry pick up and capital begins to concentrate among the top performing managers and alternative asset management firms. Low returns across traditional asset classes will bring higher investor inflows into alternative asset vehicles like hedge funds and private equity. Pending legislation will bring private equity firms and hedge funds under the surveillance of the Securities

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Industry Performance

Industry Outlook continued

and Exchange Commission for the first time, requiring many funds to hire compliance and record-keeping professionals. In addition, employing client-facing professionals to cope with a difficult fundraising environment with

more selective investors is projected to increase over the next five years. As a result of this increased specialization, IBISWorld projects industry wages to grow at an average annual rate of 0.6% through 2018 to $19.0 billion.

Industry changes ahead

The distinction between traditional and alternative asset management is expected to continue to blur over the five years to 2018. The traditional asset management sector will continue to introduce funds based on a greater range of assets and variations on traditional investing. The range of exchange-traded funds (ETFs) is expected to become more varied and complex, offering access to asset classes, hedging and leveraging strategies and potential returns similar to hedge funds. The industry is forecast to become increasingly concentrated, with institutional investors directing funds to the larger existing funds and fund issuers. Concentration is also expected to increase in the ETF sector, as increasing economies of scale give existing operators an advantage in issuing new funds because they manage larger amounts of investor capital. Convergence across the greater alternative asset sector is also

Concentration  

will increase, with institutional investors directing funds to larger existing funds
expected to continue. Alternative asset managers manage a diverse range of alternative asset vehicles such as hedge funds, funds of hedge funds, private equity funds, various debt-based funds and closed-end mutual funds. Furthermore, private equity and hedge fund groups have been buying into each other over the past few years. This merging of the different aspects of alternative asset management will be driven by both the need to attract institutional investment by offering an array of funds and the cost advantages of an increasing scale.

Regulation: costs and opportunity

IBISWorld estimates that more legislation affecting this industry will pass over the five years to 2018, hampering future industry profit, revenue and AUM. The Dodd-Frank Wall Street Reform and Consumer Protection Act require all hedge fund and private equity advisors with more than $150.0 million in AUM to register with the SEC. In addition, advisors have to hire a chief compliance officer to design and monitor a compliance program and be subject to periodic SEC oversight. The derivatives section of the

Dodd-Frank Act also has implications for hedge funds that trade in over-thecounter derivatives, as they run the risk of being classified as a “major swap participant,” which is subject to further regulation. When these provisions take effect, hedge fund and private equity advisors can expect compliance costs to decrease future profit margins. The Dodd-Frank Act’s Volcker Rule prohibits banking entities from investing in or sponsoring private equity funds, venture capital funds or hedge funds. Banks will no longer be able to engage in

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Industry Performance

Regulation: costs and opportunity continued

the practice of proprietary trading, where banks use bank funds and customer deposits, sometimes leveraging them, to make bets on securities. The rule will also limit banks to holding a 3.0% stake in private funds, which means hedge fund and private equity managers will have to compete over diminished funding from banking institutions. Major banks such as Bank of America, JPMorgan Chase and Goldman Sachs will have to decrease their exposure to private funds. Nevertheless, IBISWorld projects this rule will increase industry AUM through 2018. As banks are forced to spin off their proprietary trading desks and internal asset management divisions into standalone funds, investors will turn to hedge funds and

private equity firms to diversify their portfolios and to seek higher returns. Hedge funds in particular will become major sources of liquidity across many securities markets. Private wealth, pensions and sovereign wealth funds are also expected to increase their allocation to private equity firms as industry operators allow easier access to these clients in an effort to grow capital. Private equity, hedge funds and other investment vehicles will play an increasingly important role in US institutional and individual portfolios over the next five years in an otherwise low-return environment for traditional assets (stocks and bonds) and a depressed macroeconomic environment relative to the past decade.

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Industry Performance
Life Cycle Stage

Industry regulation is increasing There is greater concentration and convergence in the alternative asset management industry The development of new investment products and strategies is slowing Revenue and profit growth is expected to become more stable over the next five years

% Growth in share of economy

20

Company consolidation; level of economic importance stable 15

Maturity

Quality Growth

High growth in economic importance; weaker companies close down; developed technology and markets

Key Features of a Mature Industry Revenue grows at same pace as economy Company numbers stabilize; M&A stage Established technology & processes Total market acceptance of product & brand Rationalization of low margin products & brands

10

Quantity Growth
5

Many new companies; minor growth in economic importance; substantial technology change

Private Equity, Hedge Funds & Investment Vehicles
0

Loan Administration, Check Cashing & Other Services Open-End Investment Funds Portfolio Management Health & Welfare Funds Securities Brokering

-5

Decline

Shrinking economic importance

-10 -10

-5

0

5

10

15

20

% Growth in number of establishments
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Industry Performance

Industry Life Cycle This  industry is M  ature

This industry is entering the mature stage of its life cycle, after experiencing booming growth in the 2000s. The industry is rebounding after the subprime mortgage crisis hammered industry growth. However, this will be short-lived as the industry recovered and moved into a period of revenue growth, although along with greater regulation and greater consolidation. Industry value added, a measurement of the industry’s contribution to the economy, is expected to increase at a 3.5% annualized rate over the 10 years to 2018 compared with average GDP growth of 2.1% annually during the same period. The divide between investment vehicles offering traditional investment strategies and alternative funds management is expected to blur, as the risk and return profile of these funds starts to converge. Assets under management growth has largely been captured by the largest alternative asset managers. The sector is becoming more mainstream with the growing level of

institutional investment. Large alternate asset managers such as the Blackstone Group and Fortress have listed on the New York Stock Exchange (NYSE), increasing the transparency and regulation of these groups. Kohlberg Kravis & Roberts was listed on the NYSE in 2010, and industry leader the Carlyle Group went public in 2012. Product innovation will continue, although at a slower pace compared to the early 2000s, when many funds focused on mortgage-backed securities. While some products in this industry have declined in popularity, such as unit investment trusts and closed-end funds, there has been significant growth in new products. The range of complex derivative products used by hedge funds has increased dramatically over the five years to 2013. There is a large and increasing range of exchange traded products available. Investment in credit market products such as distressed debt and corporate bonds is expected to grow.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   13

Products & Markets
Supply Chain
KEY BUYING INDUSTRIES
52239

Supply Chain  |   Products & Services  |   Demand Determinants Major Markets  |   International Trade  |   Business Locations

Loan Administration, Check Cashing & Other Services in the US Issuers of mortgage-backed securities outsource most of the administration of the mortgage portfolio to third-party service providers. Portfolio Management in the US Portfolio managers increasingly place their funds under management with operators in this industry. Retirement & Pension Plans in the US Pension funds are an important source of the assets under management in this industry.

52392

52511

KEY SELLING INDUSTRIES
52 Finance and Insurance in the US Industry participants source a significant share of mortgages backing of their securities issues from the credit intermediation sector. Securities Brokering in the US Operators in this industry require trading of securities. Hedge funds account for a very high volume of trading Stock & Commodity Exchanges in the US Many of the industry’s products are listed on exchanges, such as exchange-traded funds. Custody, Asset & Securities Services in the US Operators in this industry are outsourcing an increasing range of back and middle office functions.

52312

52321 52399

Products & Services

All the financial vehicles in this industry are vehicles for the pooling of investor funds. These financial vehicles differ in their investment styles and objectives, the assets they invest in, use of leverage and regulatory requirements. They are ranked below by estimated assets under management (AUM) as a percentage of the whole alternative asset market. Private equity funds In 2013, private equity will represent an estimated 56.0% of total industry AUM. Private equity revenue is expected to be about 76.0% of total industry revenue, mainly due to poor performance by hedge funds and the decline in popularity of other alternative asset vehicles. Private equity funds normally invest in private, and sometimes public, companies, typically seeking to acquire a significant or controlling interest in the business. They are normally structured as

unregistered limited partnership funds with terms of between eight to 10 years. Private equity funds achieve returns from capital gains, and from interest, dividends and fees. Capital gains are achieved when a business is sold or its shares are sold in the public market. Private equity investments tend to be held normally for about three years or longer. Private equity tends to use financial leverage, or leveraged buyout, increasing both the potential risk and reward. Private equity will typically use investor funds to pay for a portion of an acquisition and borrow funds for the remainder of the transaction. Borrowing can typically range from 65.0% to 85.0% of the purchase price. Revenue for private equity firms typically comes from management fees based on the amount of invested capital, transaction and advisory fees as

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Products & Markets

Products & Services continued

Products and services segmentation (2013)
Structured investment vehicles

1%

Closed-end funds and unit investment trusts

3%

Hedge funds

40%

Private equity funds

56%

Total $89.2bn
capital is invested and portfolio companies are managed, and carried interest based on the performance of the fund. Hedge funds IBISWorld forecasts that in 2013 hedge funds will hold 41.0% of industry AUM, while generating only an estimated 18.0% of industry revenue due to continued poor performance. However, hedge fund AUM is projected to grow over 2013, leading hedge fund revenue to increase. The term “hedge fund” generally refers to a pooled investment vehicle that is privately organized and administered by a professional investment manager. Hedge funds normally issue securities in private offerings that are not registered with the SEC and are not widely available to the public. They are very diverse in their assets, investment strategies and risk profiles. Hedge fund managers seek to make a positive return using a range of techniques such as rapid price discovery; mathematical and statistical processing; risk measurement and control techniques; and active trading in corporate equities, bonds, foreign exchange, futures, options, swaps, forwards and other derivatives. Performance is often highly leveraged,

SOURCE: WWW.IBISWORLD.COM

which may magnify investment risk and returns. Hedge funds generate revenue from management fees and performance or incentive fees. Management fees are normally charged at the rate of 1.5% to 2.0% of AUM. Performance fees are normally charged on the annual appreciation of the assets under management, at the rate of about 20.0%. Closed-end funds and unit trusts IBISWorld estimates that in 2013 closedend funds and unit trusts will hold 2.0% of industry AUM while they generate about 4.8% of the revenue in this sector. Closeended funds hold an estimated $243.0 billion in AUM, while unit trusts hold $51.0 billion. Both closed-end funds and unit trusts saw a drop-off since 2007, when they had about $314.0 billion, while unit trusts had funds of $55.0 billion due to shifting investor preferences toward more liquid and tradable funds. A closed-end fund is a type of investment company with a fixed number of shares. Closed-end investment funds normally trade on a stock exchange after an initial public offering. Assets of these funds may be invested in stocks, bonds or a combination of both. The price of the shares is determined by the market on which they trade.

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Products & Markets

Products & Services continued

A unit investment trust (UIT) is a registered investment company that buys and holds a generally fixed portfolio of stocks, bonds or other securities. Units in the trust are sold to investors who receive their proportionate share of dividends or interest paid by the UIT investments. Unlike other investment companies, a UIT has a stated date for termination that varies according to the investments held in the portfolio. At termination, investors receive their proportionate share of the UIT net assets. These funds have an investment portfolio managed by a separate entity known as an investment adviser. Revenue is generated on these funds from fees charged to investors for managing the fund. Structured investment vehicles Structured investment vehicles (SIVs) are off-balance sheet entities of financial institutions. These structures are often known as collateralized debt obligations, or CDOs, which are a variant on a SIV. These vehicles are used to hold assets, and pass income from these assets onto investors. SIVs have grown in popularity since the mid-1990s and particularly over

the five years to 2013 as a vehicle for holding complex securitized products. These vehicles were set up predominately by investment banks, with many of them holding securitized mortgage-backed securities. These structures have tax advantages for the financial institution that sets them up and allows financial institutions to transfer risk off their balance sheet. The SIV originator receives revenue from the SIV through administration fees on the SIV such as underwriting, sales and dealing with payments. Revenue is also received from the difference between the yield on the assets held in the SIV, and the fees and interest payment made on the different branches. US investment banks had been heavily involved in sponsoring SIV, and generating revenue from their construction, marketing and sales. The subprime crisis resulted in the assets of many of these SIVs being heavily written down, and in some cases taken back onto the balance sheet of the sponsoring banks. Revenue from this source is expected to be negligible in 2012, as the result of the subprime crisis.

Demand Determinants

Alternative asset vehicle demand is determined by industry performance, the level of general economic activity, financial market conditions both in the US and globally, and larger demographic trends. The most important demand driver for alternative asset vehicles is their performance, measured by yield or investor rate of return on investment, since investors tend to gravitate toward the best performing investments. The value of the S&P 500 stock index provides a benchmark for investor equity returns but also strongly correlates to and affects industry performance in two ways. First, increasing value of the S&P 500 drives up the valuations of assets in which

many alternative asset vehicles invest in. Many hedge funds directly invest in publicly traded stocks, so a rise in the value of stocks drives up hedge fund performance. Second, private equity deal activity and revenue correlate to the equity values of the S&P 500 as well. Strong equity valuations cause more private equity firms to invest in companies and earn more when they exit investments through mergers and acquisitions (M&As) and initial public offerings (IPOs). Another key demand driver is investor uncertainty and risk tolerance. As the level of investor uncertainty declines, higher investor risk tolerance increases demand for alternative asset vehicles,

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Products & Markets

Demand Determinants continued

which tend to be more risky than more traditional investments. For the private equity market, investor risk tolerance can further be measured by investor activity in the low-rated corporate “junk” bond market. When junk bond market activity picks up, investors put more money into private equity which signals higher private equity demand. Over the five years to 2013, strong demand for speculative-grade debt was driven by investors looking for higher yields in a declining interest rate environment. As a result of central bank easing, yields on low-risk debt such as US Treasury bonds are projected to fall to record lows in 2013. Returns on equities remained sluggish during this period as well. To boost returns, investors were forced to move extend investment durations or move up the yield curve into alternative assets funds. Like the S&P 500, the yield on 10-year US Treasury Bonds serves as a benchmark rate of return on investment, which is compared to yields on alternative asset vehicles. Despite the 2011 US credit downgrade, US Treasury Bonds are still universally considered the safest investments in the world.

Investor inflows into alternative asset vehicles, represented by industry AUM, quantify industry demand. Demographic trends, such as the general aging of the population in developed countries, have led to an increase in the amount of savings, which have flowed into institutional investors such as pension funds. Pension funds and other large investors frequently buy alternative investments as they seek out high returns. This trend is likely to continue. Strong global growth, particularly within emerging economies, and the wealth generated by the rise in commodity prices have also increased the level of funds available for investment. Due to the low interest rate environment, investors are seeking diversification away from traditional equity markets as a way to generate higher returns. Institutional investors in particular will increasingly these funds into alternative asset vehicles to gain exposure to a broad array of asset classes such as private equity, emerging market debt or equity, commodities, illiquid investments and distressed and mezzanine debt. As a result, these large trends will increase industry AUM over the next five years, and by extension industry demand.

Major Markets

Institutional investors The 2008 recession fundamentally changed the way many institutional investors allocate their portfolios, with many seeking to diversify investments to better achieve their strategic goals. As a result, institutional investors have become the largest and fastest growing segment of the alternative asset market as they seek greater diversification and prospect of higher returns. IBISWorld estimates 61.0% of industry funds come from institutional investors. Funds of funds remain the largest institutional investor group at 22.0% due

to their ability to offer investors exposure to a diverse range of fund managers and asset classes. However, they declined as a share of the market over the past five years to 2013 due to heavy losses during the financial crisis and the growing trend of institutional investors favoring investment in a few individually selected funds. Both public and private pension funds represent the fastest growing and next largest institutional group with an 18.0% market share. Pension fund managers have become more sophisticated investors over the past five years, shown by their increasing

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   17

Products & Markets

Major Markets continued

Major market segmentation (2013)
Banks and insurance companies

8%

Other

4%

Funds of funds

22%

Endowments and foundations

13%

Hedge fund and private equity employees

15%

High net worth individuals

20%

Total $89.2bn

Pension funds

18%

SOURCE: WWW.IBISWORLD.COM

investment in specific hedge funds over funds of funds to achieve higher returns and make up for recession losses. Over the next five years to 2018, new legislation requirements limiting bank investment in private equity and hedge funds will shrink the 8.0% share banks and insurance companies hold in the market. Private investors Private investors make up the remaining 39.0% of industry AUM. High-net-worth individuals, who fared better during the recession than most investors, continue to contribute an estimated 20.0% of industry AUM. The rich are particularly attracted to the exclusivity and high

returns offered by the alternative asset market and will slowly increase their share of the market over the next five years to 2018. Hedge fund and private equity employees have the next largest private investor market share at 15% as many fund managers and employees commit capital to their own funds to better align their interests with those of their investors. To attract additional funding, hedge fund managers and employees will commit more capital to their own funds in the next five years to 2018. Investors perceive funds as less likely to take unnecessary risk and as safer investments when fund managers and employees are vested in the fund’s success.

International Trade

The Private Equity, Hedge Funds and Investment Vehicles industry is servicebased and does not engage in the international trade of physical goods and services. US alternative asset managers do invest in a wide range of foreign securities, commodities and

currencies that trade on securities and commodity exchanges worldwide. At the same time, foreign investors also commit capital to industry firms for investment domestically. See the Globalization section of this report for more information.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   18

Products & Markets
Business Locations 2013

West
AK
0.3

New England Great Lakes MidAtlantic
MI
2.1

ME
0.2

WA
2.0

OR
0.5

Rocky Mountains ID
0.4 1.5

MT

ND
0.0

MN

SD
0.2

Plains
IA
0.4

4.5

1 2 3 NY 6.8 5 4 6 7 8

WI
0.9

PA
3.8

WY
0.3

West NV
1.7

NE
0.1

IL
5.1

IN
0.4

OH
1.3

9

UT
1.3

CO
1.1

KS
0.3

MO
0.4

KY
0.8

WV VA 1.4
0.0

NC
2.5

CA
24.4

OK AZ
2.2 1.4

AR
0.4

Southeast
0.4

TN

SC
0.2

NM
0.9

Southwest
TX
8.3

MS
0.3

AL
0.8

GA
1.9

LA
0.8

FL
6.2

West

HI
0.4

Additional States (as marked on map) 1 VT
0.0 1.0

Establishments (%) Less than 3% 3% to less than 10% 10% to less than 20% 20% or more
SOURCE: WWW.IBISWORLD.COM

2 NH
0.5

3 MA
2.3

4 RI
0.3

5 CT

6 NJ
2.0

7 DE
3.4

8 MD
1.5

9 DC
0.4

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   19

Products & Markets

Business Locations

The West, Mid-Atlantic, Southwest and Southeast are major operating regions for the Private Equity, Hedge Funds and Investment Vehicles industry. The West is the largest region and accounts for 29.2% of industry funds. California accounts for 83.5% of all of the funds in the West because many technology companies in Silicon Valley are start-ups who need to access to growth capital provided by private equity firms. The Mid-Atlantic accounts for 17.9% of total industry funds. The large percentage of funds in this region can be attributed to the high concentration in New York and Delaware. New York’s high share of funds is a result of its proximity to key institutional clients and other investors, key brokers and the financial community, and to some of the largest and most liquid securities and commodity exchanges in the world. The high concentration of firms in Delaware can be attributed to various tax, privacy, and asset protection laws in that state, which make it company- and fund-friendly. These conditions attract various businesses including private equity funds, mutual funds and financial contract dealers, which are organized as limited liability partnerships (LLPs) and limited liability companies (LLCs). The Southwest region accounts for 12.8% industry funds. The relatively high share of establishments within this region can be attributed to the

Distribution of establishments vs. population
30

Percentage

20

10

0 Great Lakes Mid-Atlantic New England Rocky Mountains Southwest West Southeast Plains

Establishments Population
SOURCE: WWW.IBISWORLD.COM

concentration of firms in Texas. Texas accounts for about 64.5% of the Southwest region. The high concentration of open-end investment funds in Texas can be attributed to a number of funds specializing in energy as well as the headquarters of private equity firm, Texas Pacific Group. The Southeast region represents 14.2% of industry funds. Establishments in Florida account for 39.4% of the Southeast region’s establishments, since Florida has the highest share of the population in the United States who are 65 years of age or older.

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Private Equity, Hedge Funds & Investment Vehicles in the US October 2013  

20

Competitive Landscape
Market Share Concentration
Level Concentration  Concentration in this industry is low and increasing. The four largest private equity firms in this industry (Carlyle Group, Blackstone, Goldman Sachs, and Oaktree Capital Group) are estimated to hold 14.0% of industry AUM. The top five hedge funds hold an estimated 10.7% share of industry AUM. Concentration within the alternative asset management industry is increasing despite the projected 1.1% annual decline in enterprises through 2018. Before the recession, there were about 3,600 hedge funds (reflected in establishments), of which 390 managed more than $1 billion. It is estimated that the largest 390 firms managed about 80% of the industry’s

Market Share Concentration  |   Key Success Factors  |   Cost Structure Benchmarks Basis of Competition  |   Barriers to Entry  |   Industry Globalization
AUM. The subprime mortgage crisis caused a sharp drop in the number of alternative asset management funds. In 2008, about half of all alternative funds in this industry had assets of less than $100 million. It is expected that the majority of firms exiting the industry will belong to this category of small fund and growth will come from new funds by industry leading managers. Other small funds will be forced to consolidate. Investors seek the relative security of larger funds as they return to the market. As a result of these factors, the industry is expected to become more concentrated as larger funds becoming larger through acquisitions of smaller funds.

in this industry is L  ow

Key Success Factors IBISWorld  identifies 250 Key Success Factors for a business. The most important for this industry are:

Must comply with government regulations Parts of this industry are highly regulated. Operators must demonstrate compliance with regulations to attract institutional investment. Pending regulation will increase the importance of compliance in the future. Having a high prior success rate (including completed prior contracts) The past performance of securities

relative to the risk profile is an important competitive factor. Having a good reputation It is important to establish and retain a good reputation among broker-dealers and institutional and retail clients. Willingness to outsource when appropriate Most fund issuers and managers have administration of funds serviced by thirdparty providers.

Cost Structure Benchmarks

The cost structure of the financial vehicles in this industry varies depending on several factors, including the value of AUM, the type and structure of the pooled funds, whether the management style is active (as for hedge funds and private equity) or passive (as in indextracking ETFs), and regulatory compliance costs. Individual firm cost structures vary widely depending upon the mix of investment activities they engage in. For example, private equity profit depends upon successfully exiting

illiquid investments, which is heavily dependent upon the market and general economic conditions at the time. On average, private equity and hedge funds earn higher profit margins than mutual funds and exchange traded funds due to higher fees they charge for their high risk and reward investment strategies. Many of the costs related to operating a fund are paid by the fund from its assets, rather than by the fund manager, firm or fund sponsor. As a result, many of the operating costs are expenses for

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Competitive Landscape

Cost Structure Benchmarks continued

investors, and do not come out of management and performance fees. Some of the costs that are generally paid by a fund from its assets before any distribution to investors include expenses related to the custody of the fund’s assets and shareholder services. Transaction costs are large costs that come out of fund assets rather than out of fund management and performance fees. The Organization for Economic Cooperation and Development (OECD) has estimated that transaction costs for hedge funds, given the high volume of trading they undertake, may be about 25.0% of funds returns. These costs come out of the funds’ assets, not the management fee. Profit Profit in the industry is expected to account for 33.0% of industry revenue in 2013, which is up from about 28.0% in 2008, but still lower than preSector vs. Industry Costs
Average Costs of all Industries in sector (2013) 100

recessionary levels. Profit volatility increased during the recession. Pressure from investors and regulators to cut back on asset-based fees has oriented the industry towards more performancebased fees, which have been difficult to earn in volatile markets. In addition, competition from low-cost ETFs will continue to put pressure on industry funds to cut its fees to compete for investor funds. Most of the profit for private equity comes once when the investment is either sold or an IPO is conducted. Sales and IPOs usually occur during healthy economic times, which make profitability of private equity firms correlated with market conditions. Hedge funds earn profit from performance fees on fund gains. Other alternative asset vehicles, like unit trusts and closedended funds, earn profit only through fund management fees. Profit in this industry is high relative to the rest of the

Industry Costs (2013)

14.5
80

11.4 21.0 1.5 2.5 2.0 2.0

33.0

Percentage of revenue

60

■ Profit ■ Wages ■ Purchases ■ Depreciation ■ Marketing ■ Rent & Utilities ■ Other

20.7 2.0 39.3 3.0

40

20

47.1

0
SOURCE: WWW.IBISWORLD.COM

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22

Competitive Landscape

Cost Structure Benchmarks continued

financial services sector, and will continue to account for about 30.0% of revenue through 2018. Wages Wage compensation and other benefits are the largest expense incurred by operators in this industry, accounting for an estimated 20.7% of revenue for alternative asset managers. Wages may consist of a salary, plus equity-based compensation such as the issuance of share or units in the firm to employees, plus a profit-sharing component. Profitsharing arrangements give employees a share of the profit earned by funds. This better aligns the interests of employees and investors of the fund. As a result of the profit-sharing component of wages, compensation costs tend to move in line with changes in net revenue. Administration costs These include costs related to regulatory filings, record keeping, travel, communication and information services,

much of which is outsourced to securities servicing firms. Administrative costs account for 14.9% of revenue in the industry. Over the next five years, administration costs are expected to rise due to regulation requiring hedge funds to register with the Securities and Exchange Commission (SEC) and regulatory scrutiny over private equity valuation practices. Depreciation Depreciation costs are low. Most fund managers use securities servicing firms to provide IT-heavy back office function such as straight through processing, investor communication, performance analytics and other security services. This reduces the need for fund managers to invest in the information technology required to provide these services. Some funds, such as those involved in algorithmic or mathematically-based trading may have higher depreciation linked to information technology costs.

Basis of Competition
Level & Trend  ompetition C

Industry competition occurs globally, regionally, and on a niche investment basis within the industry. Firms compete for investment funds Institutions and investors base their decision to place assets with a particular fund depending on the investment performance, reputation, transaction execution skill, and range of products and services. Despite high competition for funds, the pool of investment funds globally has steadily grown over the five years to 2013, and this growth is expected to continue. Funds can also compete on the basis of their fee structure. For example, since poor hedge fund performance during the recession, institutional investors have placed pressure on hedge funds to fixed asset-

in this industry is Highand the trend  is I  ncreasing

based fees. Instead of the industry standard 2.0% fee on AUM and 20.0% fee on performance, some hedge funds have dropped down to just a 20.0% performance fee, placing downward pressure on industry pricing. As a whole, investors have become more selective in selecting alternative investment funds, with many institutional investors picking individuals funds instead of funds of funds to invest with. Competition for investment opportunities Private equity firms compete for attractive investments such as companies to add to an investment portfolio, or potential acquisition targets. There is competition for investment opportunities between managed funds, but also with

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23

Competitive Landscape

Basis of Competition continued

sovereign wealth funds and corporate buyers. Investors with lower costs of capital and access to funding sources are at an advantage in pursing investment opportunities. One of the investment strategies adopted by alternate asset vehicles is to seek arbitrage opportunities and to profit from price mismatching in the market. There will be greater competition to exploit these pricing inefficiencies as the amount of funds in alternate assets increases. Competition in the private equity market is tiered based on deal size and industry specialties. Large firms typically focus on deals over $1 billion in established industries, while middle market firms will cover deals between $15 million to $1 billion. Recently, the lack of attractive companies willing to be sold to private equity has declined which has forced larger firms into smaller mid-market deals in the $10 million to $500 million deals. Competition for employees Industry firms compete with each other to attract and retain qualified staff, including quantitative analysts and investment managers. This is particularly so for investment managers whose past performance and reputation can significantly impact a firm’s ability to raise new funds.

External competition External competition in the industry is set to increase. The industry is becoming increasingly concentrated, with institutional investors directing funds to the larger existing funds and fund issuers. Hedge funds will have to increasingly compete with lower-cost exchange traded funds (ETFs) that offer more investors access to some of the same asset classes and hedging and leveraging strategies that hedge funds use. Concentration is also expected to increase in the ETF sector, as increasing economies of scale give existing operators an advantage in issuing new funds because they manage larger amounts of investor capital. Convergence across the greater alternative asset sector is also expected to continue. Alternative asset managers, such as the Blackstone Group, manage a diverse range of alternative asset vehicles such as hedge funds, funds of hedge funds, private equity funds, various debt-based funds, and closed-end mutual funds. Private equity and hedge fund groups have been buying into each other over the past few years. This merging of the different aspects of alternative asset management will be driven by both the need to attract institutional investment by offering a breadth of funds and the cost advantages of increasing scale.

Barriers to Entry
Level & Trend  arriers to Entry B

in this industry are M  ediumand Increasing 

Having sufficient assets under management to attract institutional investment is a significant barrier for smaller hedge and private equity funds. A hedge fund may need at least $100 million in assets before it can successfully market itself to institutional investors. These funds may also need significant capital reserves at startup to tide them over a long period, possibly a number of years, before they can expect to attract

significant assets. Funds may also need several years of performance history to attract institutional investment. As a result, the projected growth in the number of funds will mainly come from established fund managers and large industry players, not new market players. Institutions normally undertake a review of funds before deciding to invest in a fund. This review includes not only the historical performance of the fund,

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Private Equity, Hedge Funds & Investment Vehicles in the US October 2013  

24

Competitive Landscape

Barriers to Entry continued

but also the efficiency of the back office functions, fund expenses and the range of investment funds on offer. Larger funds have an advantage in meeting institutional investor criteria because of their longer history and diversity of investment offerings. Fund managers with a reputation for generating aboveaverage returns will experience lower barriers to entry in launching new funds. The difficult market conditions experienced since mid-2007 have reduced the profitability of this sector. IBISWorld projects increased regulation and fund oversight, coupled

Barriers to Entry checklist
Competition Concentration Life Cycle Stage Capital Intensity Technology Change Regulation & Policy Industry Assistance

Level High Low Mature Low Medium Medium None
SOURCE: WWW.IBISWORLD.COM

with diminished profit margins, will raise industry barriers to entry from 2013 through 2018.

Industry Globalization
Level & Trend  lobalization G

in this industry is Highand the trend  is I  ncreasing

While the largest private equity and hedge funds in the world are predominately based in the United States, much of the assets under management in this industry are invested globally and attract investors from around the world. This industry is increasing its level of globalization due to a number of factors, including the rapid growth in AUM due to rising global wealth, lower international financial trading barriers, a broadening global investor base, and an increase in the number of larger alternative asset firms that operate on a global basis.

IBISWorld estimates the US share of the total private market will decline over the next five years to 2018 as emerging market growth and more sophisticated global debt markets push up mergers and acquisitions (M&As) around the world. Cross-border financial flows tripled over the past decade and then fell by 82% in 2008, according to the McKinsey Global Institute. Cross-border capital flow increased in 2013 and this trend is expected to continue over the next five years to 2018.

WWW.IBISWORLD.COM

Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   25

Major Companies
Other Companies

There are no Major Players in this industry   |   Other Companies

The alternative asset investment market is highly fragmented and does not have any major players with even a 5.0% market share. This is mainly due to the relatively new and rapidly evolving alternative asset market, low barriers to entry and high demand from wealthy investors seeking specialized asset diversification for their portfolios. Listed below are leading alternative asset management firms and hedge funds that have impacted the industry, ranked by their percentage of total assets under management (AUM).

The Blackstone Group

Estimated market share: 4.6% The Blackstone Group is the largest group of independent private capital managers and alternative investment advisory service providers in the world with $210.2 billion in total AUM. Its private equity and alternative asset management segments include the management of private equity funds, real estate funds, funds of hedge funds and credit funds. In addition, it provides financial advisory services on the reorganization and placement of funds. Founded in 1985, Blackstone operates in 25 global offices with 1,780 total employees and 290 investment professionals focusing on private equity and hedge fund investments. IBISWorld estimates total firm revenue will grow 2.8% over 2013 to about $4.1 billion, primarily due to fees associated with the increase in AUM during the year.

The Carlyle Group

Estimated market share: 4.2% The Carlyle Group, founded in 1987 in Washington, DC, is one of the world’s largest alternative asset managers with about $170.0 billion in AUM across 113 funds and 67 fund of funds (which are mutual funds that invest in other mutual funds) vehicles. It employs more than 1,400 professionals in 33 offices in the

Americas, Europe, the Middle East, Asia, Australia and parts of Africa. The company serves about 1,500 investors in 75 countries worldwide. About 52.0% of its AUM is based in the Americas. Carlyle operations are diversified across a number of alternative asset classes, although private equity still accounts for about 45.1% of its revenue. The company’s four divisions are corporate private equity, global market strategies, real assets and solutions (which handles funds of funds). Its corporate private equity segment includes funds that invest in buyout and growth transactions in particular geographies or industries. The global market strategies segment houses funds that pursue investment opportunities across credit, equity and alternative instruments such as currencies, commodities, sovereign debt, interest rate products and their derivatives. Funds that invest in real estate, infrastructure, energy and renewable energy transactions are housed in its real assets segment. Through its solutions segment, Carlyle invests in private equity fund of funds, related co-investment and secondary debt market opportunities. In January 2011, the Carlyle Group established itself as the alternative asset market leader through its acquisition of AlpInvest Partners and its $55.0 billion in AUM. A leader in the European market, AlpInvest has historically been the exclusive manager of private equity investments for investment managers of two of the world’s largest pension funds, Stichting Pensioenfonds ABP and Stichting Pensioenfonds Zorg en Welzijn, both based in the Netherlands. The acquisition will add a leading fund of funds and secondary platform, significantly expanding Carlyle’s global asset management business. In August 2012, the Carlyle Group acquired a 60.0% stake in the TCW Group, a Los Angeles-based asset management firm.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   26

Major Companies

Other Companies continued

TCW has $130 billion assets under management and is involved in the alternative asset market. In May 2012, the Carlyle Group became the fifth alternative asset management firm to go public, solidifying its position as one of the industry’s leading firms. Over five years to 2013, its AUM grew at a compound rate of 14.9%. Total revenue is estimated to grow 2.9% over 2013 to an expected $3.0 billion.

significantly reduce its own investments in private equity from 37.0% to about 3.0%.

Oaktree Capital Group

Goldman Sachs Capital Partners

Estimated market share: 3.3% Goldman Sachs, a US bank holding company, operates through four distinct business divisions: investment banking, institutional client services, investing and lending and investment management. Industry-specific revenue is categorized under its investment management segment, with its alternative investments. Goldman Sachs’ alternative investments include hedge funds, credit funds, private equity, real estate, currencies, commodities and asset allocation strategies. GS Capital Partners VI is the current primary investment vehicle for Goldman Sachs to make large, privately negotiated equity investments. The group, based in New York City, was founded in 1986. IBISWorld estimates Goldman Sachs holds and manages $133 billion in alternative assets, giving it a 3.3% market share in 2013. Goldman Sachs’s alternative assets have been declining at an annualized rate of 1.8% over the five years to 2013. Goldman Sachs believes that there will be a “private equity cliff” and that there are not as many investment opportunities that will have good returns. Goldman Sachs’s alternative assets are going to further decline due to the Dodd-Frank ruling that disallows banks from making big bets with their own money. It is expected that GS Capital Partners VI will have to

Estimated market share: 1.9% Oaktree Capital is a global investment manager, specializing in alternative investments. Founded in 1995, Oaktree Capital is headquartered in Los Angeles. Oaktree Capital’s company revenue totaled $1.41 billion in 2012, according to the latest financial information. The company employs 229 investment professionals to manage $77.1 billion in assets under management; of this amount, about $31.3 billion in AUM are industryspecific through their open-end funds and evergreen funds. Evergreen funds are funds that invest in marketable securities on a long and short basis. Oaktree Capital has over 1,750 clients, including 75 of the 100 largest US pension plans, 400 corporations, 300 universities and over 250 non-US institutional investors.

TPG Capital

Estimated market share: 1.3% TPG Capital (formerly known as Texas Pacific Group) is a top private investment firm, founded in 1992, with $56.7 billion in assets under management. Through more than 18 private equity funds, the company focuses on leverage buyouts, growth capital and leveraged recapitalization investments in distressed companies and turnaround situations. TPG Capital primarily focuses on acquiring and restructuring companies in financial services, travel and entertainment, technology, retail, consumer products, healthcare and media and communications industries. It is headquartered in Fort Worth, TX but has operations in 17 offices in 10 countries.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   27

Major Companies

Other Companies continued

Hedge funds IBISWorld estimates that the top five hedge funds in the United States, based on their global AUM are: Bridgewater Associates, with about $140 billion in AUM, has a 3.5% market share; JP Morgan Asset Management manages about $121.0 billion in AUM, giving it a 3.0% market share; Blackrock Advisors

has about $104 billion alternative assets under management, giving it a 2.6% market share; Och-Ziff Capital Management, the largest publicly-traded hedge fund manager, has about $36.3 billion in AUM, giving it a 0.9% market share; and Soros Fund Management manages about $ $28.0 billion, giving it a market share of 0.7%.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   28

Operating Conditions
Capital Intensity
Level The level  The major expense for hedge funds and private equity funds is employee compensation, with a large portion of staff benefits linked to fund performance. This means the industry spends much more on labor than on capital, resulting in low capital intensity. Industry capital intensity is especially low compared to the greater financial services sector due to higher wages and significant outsourcing of capital intensive IT functions. While there can be significant administration and servicing costs for alternative asset management, these costs are outsourced and in many cases are an expense incurred by funds investors rather than fund operators. Closed-ended funds may outsource not only their servicing but also their

Capital Intensity   |   Technology & Systems   |   Revenue Volatility Regulation & Policy   |   Industry Assistance

Capital units per labor unit 0.5 0.4 0.3 0.2 0.1 0.0 Economy Finance and Insurance Private Equity, Hedge Funds & Investment

Capital intensity

of capital intensity is L  ow

Dotted line shows a high level of capital intensity
SOURCE: WWW.IBISWORLD.COM

active management to third parties. These can be affiliated organizations or independent contractors. The

Tools of the Trade: Growth Strategies for Success
New Age Economy Recreation, Personal Services, Health and Education. Firms benefit from personal wealth so stable macroeconomic conditions are imperative. Brand awareness and niche labor skills are key to product differentiation. Investment Economy Information, Communications, Mining, Finance and Real Estate. To increase revenue firms need superior debt management, a stable macroeconomic environment and a sound investment plan.

Capital Intensive

Labor Intensive

Traditional Service Economy

Open-End Investment Funds Portfolio Management

Private Equity, Hedge Funds & Investment Vehicles
Loan Administration, Check Cashing & Other Services Securities Brokering Health & Welfare Funds
Old Economy

Wholesale and Retail. Reliant on labor rather than capital to sell goods. Functions cannot be outsourced therefore firms must use new technology or improve staff training to increase revenue growth.

Agriculture and Manufacturing. Traded goods can be produced using cheap labor abroad. To expand firms must merge or acquire others to exploit economies of scale, or specialize in niche, high-value products.
SOURCE: WWW.IBISWORLD.COM

Change in Share of the Economy

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   29

Operating Conditions

Capital Intensity continued

need for a branch network, technological and communications equipment is virtually non-existent. Consequently, fund sponsors do not

have a great demand for direct human resources. Most funds management staff is employed indirectly by portfolio managers.

Technology & Systems
Level The level 

of Technology Change is M  edium

In the sale of fund shares, sponsors and their third party service providers utilize technology to improve the efficiency and effectiveness in the distribution of services to clients. The shift in investments towards the use of telecommunication services, information technologies and electronic distribution technologies is expected to continue. Information

technology improvements are allowing for greater globalization of trading platforms and settlement systems, and the trading of more diverse and complex financial products. Improvements in technology and the increasing scale of technology infrastructure are lowering the cost of trading in overseas markets and of servicing assets under management.

Revenue Volatility
Level The level 

of Volatility is H  igh

For the industry as a whole (encompassing hedge funds, private equity funds and other alternative investments) revenue volatility is high, fluctuating between a decline of 25.2% and growth of 15.8% over the five years to 2013, fluctuating at an absolute average annual rate of 14.7%. Hedge fund and private equity revenue, in particular, are volatile due to the large share of revenue linked to fund performance. Industry revenue is also
A higher level of revenue volatility implies greater industry risk. Volatility can negatively affect long-term strategic decisions, such as the time frame for capital investment. When a firm makes poor investment decisions it may face underutilized capacity if demand suddenly falls, or capacity constraints if it rises quickly.

dependent upon the level of assets under management, which although is increasing, still swings in value from year to year with changes in capital markets. Funds in this industry are exposed to a wide range of sectors, asset types and geographic locations diversifying the return risk. Many of the firms in this industry use a high level of leverage, which can magnify investment gains and losses, impacting performance fees.

Volatility vs Growth
1000

Hazardous

Rollercoaster

Revenue volatility* (%)

100 10 1 0.1

Private Equity, Hedge Funds & Investment Vehicles

Stagnant
–30 –10 10 30 50

Blue Chip
70

Five year annualized revenue growth (%)
* Axis is in logarithmic scale
SOURCE: WWW.IBISWORLD.COM

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   30

Operating Conditions

Regulation & Policy
Level & Trend  he level of T

Regulation is Mediumand the  trend is I  ncreasing

Investment Company Act of 1940 The Investment Advisers Act of 1940 regulates the conduct of fund investment managers and requires them to register with the SEC. The Act imposes restrictions not only on the funds themselves but also fund investment advisers, principal underwriters, directors, officers and employees. It requires that funds maintain detailed books and records, safeguard their portfolio securities and file semiannual reports with the SEC. It also grants the SEC broad discretionary powers to keep the Act current with the constantly changing financial services industry environment. The Securities Act of 1933 Investment funds must comply with the Securities Act of 1933 when registering their shares publicly, and must provide notice filings to those states in which they intend to offer their shares. The Act also requires that all prospective investors receive a current prospectus describing the fund. As of September 23, 2013 the provision of the act prohibiting industry operators from advertising and general solicitation has been lifted. Hedge funds, venture capital and private equity funds are now able to advertise their offerings as long as all sales are made to accredited investors or qualified institutional buyers. Other funds Money market funds are regulated primarily under the Investment Company Act of 1940 and the rules adopted under that Act, particularly Rule 2a-7 under the Act. Closed-end funds are subject to SEC registration and regulation. They are regulated primarily under the Investment Company Act of 1940. Closed-end funds are also subject to the Securities Act of 1933 and the Securities Exchange Act of 1934. They are also subject to the

oversight of the exchanges on which their shares are listed. Hedge funds Hedge funds are typically structured as limited partnerships, limited liability companies or offshore corporations. Hedge funds are not required to register with the SEC under the Securities Act of 1933. In addition, hedge funds are not required to make periodic reports under the Securities Exchange Act of 1934. Hedge funds are subject to the same prohibitions against fraud as are other market participants, and their managers have the same fiduciary duties as other investment advisers. In February 2006, the SEC introduced registration requirements for hedge fund advisors. In June 2006, the Court of Appeals vacated this rule due to its “arbitrary” nature and by December 2006, about 275 hedge fund advisors had withdrawn their registration with the SEC. The hedge fund subcommittee of the President’s Working Group on Financial Markets has produced voluntary industry standards. At the April 2009 G-20 summit, member countries, including the United States, agreed on reforms to strengthen their respective financial regulatory systems. The agreement requires that hedge funds or their manager be registered and be required to disclose appropriate information, including leverage, on an ongoing basis to regulators. Regulation will most likely be subject to an appropriate size. Hedge funds will be required to have adequate risk management. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 The Dodd-Frank Act requires all hedge fund and private equity advisors with over $150 million in AUM to register with the SEC. In addition, they have to hire a chief compliance officer to design

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   31

Operating Conditions

Regulation & Policy continued

and monitor a compliance program, and be subject to periodic SEC oversight. The derivatives section of the Dodd-Frank Act also affects hedge funds. For example, hedge funds that trade in OTC derivatives may be classified as a “major swap participant” subjecting itself to further regulation. Volcker Rule of 2011 The Volcker Rule prohibits banking entities from investing in or sponsoring private equity funds,

venture capital funds, or hedge funds. Banks will no longer be able to engage in the practice of proprietary trading, where banks use bank funds and customer deposits, sometimes leveraging them, to make bets on securities. The rule will also limit banks to holding a 3% stake in private funds which means hedge fund and private equity managers will have to compete over diminished funding from banking institutions.

Industry Assistance
Level & Trend  he level of T

Industry Assistance is N  oneand the trend is S  teady

The Private Equity, Hedge Funds and Investment Vehicles industry does not receive any direct government assistance in the form of tariffs or direct monetary stimulus. IBISWorld does not anticipate the industry will receive any kind of government assistance over the next five years. Private equity firms and hedge funds

have historically benefited from low regulation oversight and disclosure requirements in the United States relative to mutual funds. However, increased scrutiny on the overall financial sector in the wake of the financial crisis is bringing the industry’s regulatory burden in line with the overall asset management sector.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   32

Key Statistics
Industry Data
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Sector Rank Economy Rank Revenue ($m) 52,813.9 58,825.9 71,941.1 86,946.2 65,055.1 69,858.3 80,905.8 80,759.8 87,915.5 89,169.4 92,566.9 95,602.8 98,492.2 102,728.8 107,661.1 17/64 110/1299 Industry Value Added ($m) 29,735.3 32,476.0 42,014.8 56,030.1 37,867.1 41,884.0 47,574.0 45,340.7 46,302.5 49,623.6 48,623.9 49,302.8 49,116.1 50,291.0 53,409.4 12/64 54/1299 Establishments 11,063 10,972 11,148 11,672 11,454 11,001 10,910 10,870 10,978 11,098 10,815 10,686 10,491 10,450 10,510 21/64 330/1298 Enterprises Employment 11,063 75,002 10,972 73,388 11,148 76,984 11,672 81,526 11,454 75,208 11,001 73,739 10,910 68,631 10,870 69,582 10,978 70,671 11,098 71,931 10,815 70,065 10,686 68,548 10,491 68,477 10,450 68,432 10,510 68,546 14/64 24/64 288/1298 428/1299 Exports ---------------N/A N/A Imports ---------------N/A N/A Wages ($m) 11,250.5 12,475.3 15,396.6 20,382.2 18,350.5 17,992.5 17,638.8 17,882.4 17,290.4 18,414.3 18,076.8 17,753.9 17,598.6 18,445.1 18,957.8 13/64 87/1299 Total Assets ($m) 2,398,767.4 2,671,159.4 3,267,652.2 3,948,531.8 3,096,304.1 3,325,852.7 3,675,306.1 3,668,528.3 3,993,756.6 4,050,700.5 4,204,222.0 4,343,802.2 4,475,853.8 4,666,972.8 4,890,987.5 6/12 6/18 S&P 500 Value (Index) 1,134.0 1,207.8 1,318.3 1,478.1 1,215.2 948.5 1,130.7 1,280.8 1,386.5 1,605.6 1,685.0 1,759.3 1,839.7 1,953.7 2,031.5 N/A N/A

Annual Change
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Sector Rank Economy Rank Revenue (%) 11.4 22.3 20.9 -25.2 7.4 15.8 -0.2 8.9 1.4 3.8 3.3 3.0 4.3 4.8 39/64 926/1299

Industry Value Added (%) 9.2 29.4 33.4 -32.4 10.6 13.6 -4.7 2.1 7.2 -2.0 1.4 -0.4 2.4 6.2 8/64 211/1299

Establishments (%) -0.8 1.6 4.7 -1.9 -4.0 -0.8 -0.4 1.0 1.1 -2.6 -1.2 -1.8 -0.4 0.6 35/64 682/1298

Enterprises Employment (%) (%) -0.8 -2.2 1.6 4.9 4.7 5.9 -1.9 -7.7 -4.0 -2.0 -0.8 -6.9 -0.4 1.4 1.0 1.6 1.1 1.8 -2.6 -2.6 -1.2 -2.2 -1.8 -0.1 -0.4 -0.1 0.6 0.2 28/64 29/64 606/1298 578/1299

Exports (%) N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A

Imports (%) N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A

Wages (%) 10.9 23.4 32.4 -10.0 -2.0 -2.0 1.4 -3.3 6.5 -1.8 -1.8 -0.9 4.8 2.8 9/64 146/1299

Total Assets (%) 11.4 22.3 20.8 -21.6 7.4 10.5 -0.2 8.9 1.4 3.8 3.3 3.0 4.3 4.8 9/12 10/18

S&P 500 Value (%) 6.5 9.1 12.1 -17.8 -21.9 19.2 13.3 8.3 15.8 4.9 4.4 4.6 6.2 4.0 N/A N/A

Key Ratios
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Sector Rank Economy Rank IVA/Revenue (%) 56.30 55.21 58.40 64.44 58.21 59.96 58.80 56.14 52.67 55.65 52.53 51.57 49.87 48.96 49.61 7/64 180/1299

Imports/ Demand (%) N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A

Exports/ Revenue (%) N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A

Revenue per Employee ($’000) 704.17 801.57 934.49 1,066.48 865.00 947.37 1,178.85 1,160.64 1,244.01 1,239.65 1,321.16 1,394.68 1,438.33 1,501.18 1,570.64 17/64 79/1299

Wages/Revenue (%) 21.30 21.21 21.40 23.44 28.21 25.76 21.80 22.14 19.67 20.65 19.53 18.57 17.87 17.96 17.61 20/64 542/1299

Employees per Est. 6.78 6.69 6.91 6.98 6.57 6.70 6.29 6.40 6.44 6.48 6.48 6.41 6.53 6.55 6.52 46/64 895/1298

Average Wage ($) 150,002.67 169,991.01 199,997.40 250,008.59 243,996.65 244,002.50 257,009.22 256,997.50 244,660.47 255,999.50 258,000.43 258,999.53 257,000.16 269,539.10 276,570.48 4/64 6/1299

Share of the Economy (%) 0.24 0.26 0.32 0.42 0.29 0.33 0.36 0.34 0.34 0.36 0.34 0.34 0.32 0.32 0.33 12/64 54/1299

Figures are inflation-adjusted 2013 dollars. Rank refers to 2013 data.

SOURCE: WWW.IBISWORLD.COM

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   33

Jargon & Glossary

Industry Jargon

ALTERNATIVE ASSETSCommodities, derivative products, private equity, real estate, and other nontraditional assets. ASSETS UNDER MANAGEMENT (AUM)The assets (e.g. equities, fixed income, real estate and alternative assets) managed on behalf of clients. COLLATERALIZED DEBT OBLIGATIONS (CDO)An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds. FUND REDEMPTIONWhen investors seek the return of their principals from alternative asset funds under the limitations of the fund issuer. HEDGE FUNDAn aggressively managed portfolio of investments that uses advanced investment strategies to generate high returns. Hedge funds have a limited number of investors and require high initial investment.

INITIAL PUBLIC OFFERINGS (IPO)The first sale of stock by a private company to the public. IPOs are issued by younger companies seeking the capital to expand, but also by large private companies looking to become publicly traded. LEVERAGINGAn act of investing with borrowed money that may magnify potential risks and returns. PRIVATE EQUITYConsists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. STRUCTURED INVESTMENT VEHICLE (SIV)A form of off balance sheet conduit of financial institutions. SIVs are used to hold assets and pass on income from those assets to investors.

IBISWorld Glossary

BARRIERS TO ENTRYHigh barriers to entry mean that new companies struggle to enter an industry, while low barriers mean it is easy for new companies to enter an industry. CAPITAL INTENSITYCompares the amount of money spent on capital (plant, machinery and equipment) with that spent on labor. IBISWorld uses the ratio of depreciation to wages as a proxy for capital intensity. High capital intensity is more than $0.333 of capital to $1 of labor; medium is $0.125 to $0.333 of capital to $1 of labor; low is less than $0.125 of capital for every $1 of labor. CONSTANT PRICESThe dollar figures in the Key Statistics table, including forecasts, are adjusted for inflation using the current year (i.e. year published) as the base year. This removes the impact of changes in the purchasing power of the dollar, leaving only the “real” growth or decline in industry metrics. The inflation adjustments in IBISWorld’s reports are made using the US Bureau of Economic Analysis’ implicit GDP price deflator. DOMESTIC DEMANDSpending on industry goods and services within the United States, regardless of their country of origin. It is derived by adding imports to industry revenue, and then subtracting exports. EMPLOYMENTThe number of permanent, part-time, temporary and seasonal employees, working proprietors, partners, managers and executives within the industry. ENTERPRISEA division that is separately managed and keeps management accounts. Each enterprise consists of one or more establishments that are under common ownership or control.

ESTABLISHMENTThe smallest type of accounting unit within an enterprise, an establishment is a single physical location where business is conducted or where services or industrial operations are performed. Multiple establishments under common control make up an enterprise. EXPORTSTotal value of industry goods and services sold by US companies to customers abroad. IMPORTSTotal value of industry goods and services brought in from foreign countries to be sold in the United States. INDUSTRY CONCENTRATIONAn indicator of the dominance of the top four players in an industry. Concentration is considered high if the top players account for more than 70% of industry revenue. Medium is 40% to 70% of industry revenue. Low is less than 40%. INDUSTRY REVENUEThe total sales of industry goods and services (exclusive of excise and sales tax); subsidies on production; all other operating income from outside the firm (such as commission income, repair and service income, and rent, leasing and hiring income); and capital work done by rental or lease. Receipts from interest royalties, dividends and the sale of fixed tangible assets are excluded. INDUSTRY VALUE ADDED (IVA)The market value of goods and services produced by the industry minus the cost of goods and services used in production. IVA is also described as the industry’s contribution to GDP, or profit plus wages and depreciation.

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Private Equity, Hedge Funds & Investment Vehicles in the USOctober 2013   34

Jargon & Glossary

IBISWorld Glossary continued

INTERNATIONAL TRADEThe level of international trade is determined by ratios of exports to revenue and imports to domestic demand. For exports/revenue: low is less than 5%, medium is 5% to 20%, and high is more than 20%. Imports/domestic demand: low is less than 5%, medium is 5% to 35%, and high is more than 35%. LIFE CYCLEAll industries go through periods of growth, maturity and decline. IBISWorld determines an industry’s life cycle by considering its growth rate (measured by IVA) compared with GDP; the growth rate of the number of establishments; the amount of change the industry’s products are undergoing; the rate of technological change; and the level of customer acceptance of industry products and services. NONEMPLOYING ESTABLISHMENTBusinesses with no paid employment or payroll, also known as nonemployers. These are mostly set up by self-employed individuals.

PROFITIBISWorld uses earnings before interest and tax (EBIT) as an indicator of a company’s profitability. It is calculated as revenue minus expenses, excluding interest and tax. VOLATILITYThe level of volatility is determined by averaging the absolute change in revenue in each of the past five years. Volatility levels: very high is more than ±20%; high volatility is ±10% to ±20%; moderate volatility is ±3% to ±10%; and low volatility is less than ±3%. WAGESThe gross total wages and salaries of all employees in the industry. The cost of benefits is also included in this figure.

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