1. Industry Overview – How Are Investment Banking, Private Equity and Hedge Fund Different?

 

1.1. Sell-Side Versus Buy-Side

Investment bankers work on the sell-side, meaning they sell business interest to investors. Investment banks tend to act as middle-man, with two main functions: advise on capital raising & strategic development and seek prospective investors to distribute stocks and bonds. Combining both, from advisory to distribution, is called “underwriting”.

Conversely, private equity firms and hedge funds work on the buy-side. They purchase business interests on behalf of investors who have already put up the money. At a basic level, private equity firms buy controlling interests in other businesses and are directly involved in management decisions, whereas hedge funds use complicated techniques and strategies to make high-risk, high-return investments.

 
Investment BankingPrivate EquityHedge Fund
Group
Sell sideBuy side

Buy side

Definition

An Investment Bank (IB) is a financial intermediary that offers a variety of services to both individual and institutional investors in underwriting (capital raising), and executing (distribution, strategic transaction advisory)

A private equity (PE) firm is an entity that raises capital from outside investors to invest in private company (not listed in stock exchange)

A Hedge Fund (HF) is an investment pool that gathers capital from only institutional and accredited individuals to acquire smaller stakes in companies or liquid financial assets such as stocks, bonds, derivatives, among others.
Purpose
Investment banks help guide corporations when going public, raising capital, and through mergers and acquisitions.PE firms buy underperforming and potential companies, then improve the operations to increase their value over long term. Private equity is a lot more about control and taking over an entire business. The eventual goal is to sell the companies to reap high returns for their investors. The lock-in period in private equity typically ranges from 3 to 5 years.

Hedge fund managers are highly focused on short-term profits. The sole goal is to get the highest returns on investments in the lowest amount of time. The holding period in hedge funds can typically be as short as three months to 3 years.

Form
Capital raising/ Advisory service
Investment business

Investment business

 

Capital Market Program

Ideal program for any student who wants to work in capital markets, whether on the buy-side or the sell-side.

 
I want to know more!

2. Nature of Work: Investment Banking vs Private Equity vs Hedge Fund

 
Invesment BankingPrivate EquityHedge Fund

Key responsibilities

Performing valuation, and develop financial models

Creating pitchbook

Performing due diligence, research, analysis, and documentation of live transactions.

Doing administrative work

Fundraising

Screening for and making investments

Managing investments and portfolio companies

Exit strategy

Building industry expertise

Conducting company research and sectoral analysis

Forecasting financials of companies and making financial models

Making investment decisions

Hierarchy

Analyst

Associate

Vice President

Director/ Principal/ Senior Vice President

Managing Director

 

Analyst

Associate

Senior Associate 

Principal/ Vice President

Managing Director

 

Research Analyst

Research Associate

Senior Analyst/ Sector Head

Associate Portfolio Manager

Portfolio Manager (General Partner)

 

 

2.1. Job Responsibility

Investment bankers spend the first few years of their careers immersed in financial modeling, comparative analysis, and preparing presentations and pitchbooks. But as they climb the ladder to senior roles (VP, MD), they get the opportunity to do more execution work and project management like pitching potential clients on deals, getting involved in deal negotiation and developing relationships to win clients. 

Similar to investment banking, those working in private equity spend a lot of time in Word, Excel, and PowerPoint, but private equity work is more than just company research and valuation. Research and modeling are essential parts of the private equity skill set, but quarterbacking the deal process with consultants, banks, lawyers will take up the majority of time.

Hedge Fund professionals, on the other hand, perform a highly research-focused job and don’t have the transaction work. The daily tasks at traditional hedge funds fall into just two categories: research and analysis.  Hedge fund analysts focus on using complex algorithms and well-tested risk management techniques (Long/short equity, Market neutral, Merger Arbitrage, etc.) to secure the highest rate of return. Everything is shorter-term and higher-tempo, there are no deals, and portfolio companies don’t exist in the same way, so you spend time crunching numbers, doing research, and building investment theses. Analysts at hedge funds are expected to cover more companies than their private equity counterparts, and the research is done at a much faster pace.

 

2.2. Career Path

There’s a difference in the skills for promotion in investment banking and private equity versus hedge funds. 

To go higher up the ladder in private equity, analysts need to

  • Source good deals.
  • Have strong relationships with investment banks to get bank financing.
  • Recruit good management for your portfolio companies.

What’s the similarity among the 3 key factors? They all require having a strong personal network. To be successful, it helps to know the right bankers and industry professionals. A junior person at a private equity and investment bank, is responsible for the fundamental analysis of companies and not so much the relationship building. But as he moves up in the ranks, he will be expected to use your network to source deals.  So to get to a partner level in private equity, having a strong network is essential. 

Similarly, at the more senior level, investment bankers are aggressive salespeople. They have to present results to their clients, for the purposes of decision making. This means that an investment banker should ideally have strong communication acumen and a large network to reach out to. Naturally, strong people skills will aid in the job of an investment banker.

Relationships matter in all industries, but it matters more in private equity and investment banking than in hedge funds.

On the hedge fund side, the end-all be-all is generating good annual returns on the portfolio. The deeper you know about your industries and companies, the more likely you’ll put up good performances. Hedge Fund portfolio managers are expected to market the fund as well, so having good relationships definitely matter. But strong research is the foundation to market the fund effectively.

 

3. Compensation in Investment Banking, Private Equity, Hedge Fund – Which Pays Better?

 

3.1. Investment Banking 

Typically the bonus pay for investment bankers is between 30-100% of base salary, based on seniority. Salary range for investment bankers also depends on the types of banks they work for:  bulge bracket banks, middle-market banks, and boutique banks. While the Bulge bracket tends to defer a large portion of monus to next year or pay in stocks, Middle-market  and Boutique pay bonus in cash. 

 
Position TitleBase Salary (USD)Total Compensation (USD)Timeframe for Promotion Next Level
Analyst$100-$150KUnlikely2-3 years
Associate$150-$300K Unlikely2-3 years
Senior Associate$250-$400KSmall3-4 years
Vice President (VP)$350-$500KGrowing5 years
Director or Principal
$500-$800KLarge5-10 years
Managing Director (MD) or Partner
$700-$2MVery LargeN/A

3.2. Private Equity

2020 BBB

The real pay advantage in private equity comes from carried interest (“carry”), which usually becomes available only as you move up to the VP / Principal and the MD / Partner levels. In Private Equity, carry is the profit earned between buying a business and then selling it and this is the key component of senior compensation. It is basically additional upside to their compensation over the long-run and is tied to the performance of the fund. If you are interested in Carried Interest Mechanist, you can read more on our Private Equity Salary and Bonus with a detailed example.

Position Title

Base Salary + Bonus (USD)

Carried Interest

Time for Promotion to Next Level

Analyst

$100-$150K

Unlikely

2-3 years

Associate

$150-$300K

Unlikely

2-3 years

Senior Associate

$250-$400K

Small

3-4 years

Vice President (VP)

$350-$500K

Growing

5 years

Director or Principal

$500-$800K

Large

5-10 years

Managing Director (MD) or Partner

$700-$2M

Very Large

N/A

3.3. Hedge Fund 

The pay structure is likely to be completely different at these two types of funds.

  • Single-manager fund compensation is more steady with a base plus bonus (just like in private equity), but the upside is likely to be capped at ~$200-300K during the first few years.
  • Multi-manager fund compensation is tied to fund performance. If the fund has a good year and generates a lot of P&L, then an associate can get paid upwards of $500K-$1MM during his first few years. However, the flip side is true as well. If his team does not make any money in a given year, then he does not get any bonus and makes less than what he did in banking. 
 
Position TitleBase Salary + Bonus (USD)Time for Promotion to Next Level
Research Analyst$100K – $150K2-3 years
Research Associate$200K – $600K3-4 years
Senior Associate or Sector Head$500K – $1 million3-5 years
Portfolio Manager$500K – $3 millionN/A

Key Takeaways

  • You can earn a lot of money if you’re successful in any of the 3 fields, but the compensation ceiling is far higher in private equity and hedge fund than it is for investment banking
  • Investment banking, irrespective of a good or bad year, largely remains the same as the client base remains the same.
  • Compensation on the buy side is more variable depending on fund performance. PE’s and HF’s people can make substantially more than investment banking if the fund does well.
  • Senior levels at private equity get a percentage of the P&L (what they call “carried interest”). With PE, people are slightly more committed to the fund as they have to stay with the firm until the carry payments are being paid out. A managing director in investment banking could get an annual bonus of $250,000-$1m+, whereas, in PE at a fund that is performing well, an MD could pull $1.0m-5.0m+ in carry payments each year at the senior level.
  • Hedge fund pay is less structured compared to investment banking and private equity. However, it is extremely volatile and completely dependent on a fund’s performance. So pay levels can swing significantly from year to year. 

4. Exit opportunities for Investment Banking vs Private Equity vs Hedge Fund

 

4.1. Investment Banking

Investment bankers have the widest set of exit opportunities. The most popular paths to exit for bankers are Private Equity, Hedge Fund, Venture Capital, Asset Management, Corporate Development, and Corporate Finance, tech startup, and so much more. 

 

4.2. Private Equity

Compared to investment banking, exit options are a bit more limited for private equity professionals just because PE firms are less well-known outside finance. Everyone worldwide knows Goldman Sachs, but most people outside the finance industry have never heard of KKR or Blackstone, let alone top middle-market funds such as ABRY. 

That being said, private equity still offers good exit opportunities. In the job you learn how to manage a process with multiple counterparties (deal teams, lawyers, management teams, tax/supply chain advisors). Also, as you get more senior you learn to start managing others below you. These skill sets are very transferable to other types of roles. PE professionals could move to Corporate Finance, Corporate Development, other buy-side roles like Hedge Funds or Venture Capital, or you could even move back into IB.

 

4.3. Hedge Fund

Exit opportunities for a Hedge Fund analyst are substantially less: you could either stay and get promoted, you could join another closely related fund, or you could go to b-school to make a complete switch. 

The skills you develop at hedge funds are more specialized. You are usually not managing a team/process and work pretty independently. You don’t have the deal skills that PE firms and corporate development teams look for, you won’t look that appealing to most VC firms, and you won’t have enough “management” experience to join most normal companies. Your exit ops are geared more to other investing and corporate finance roles in the industries that you have covered. 

This is also why it tends to be easier to move from investment banking and private equity to hedge funds than to do the reverse.

 

5. Recruiting Comparison: Investment Banking vs Private Equity vs Hedge Fund – How to break in?

5.1. Investment Banking

2020 BBB

Investment banking is the easiest to break into compared to private equity and hedge funds. There are two entry-level positions that you should aim for in investment banking: analyst and associate. Whereas analyst roles are for college fresh graduates , master’s degree holders or those who have less than 7 years of experience, associates are selected from top-notch MBA universities. 

Candidates seeking to make a career in investment banking should be ready for enormously tough competition from graduates from top business schools and universities. Top strategies to successfully land a career in investment banking are:

  • Go to target school: You are at a huge advantage if you come from a target school where banks heavily recruit such as Wharton, Harvard or London School of Economics. Otherwise, you’ll have to focus more on networking to stand out. 
  • Gain relevant experience: having finance experience is a prerequisite for an entry-level position in the firm. Finance clubs, stock picking teams, case competitions, or banking internships can show recruiters your interest in finance.
  • Networking plays a major role in breaking through large corporate players, having the right contacts help to give you an advantage amongst others. Being liked is the strongest factor in finance recruiting because while there are plenty of capable people, not all capable people are likeable or suitable. And investment banking is a people business so communication and networking skills are highly important.

5.2. Private Equity

PEAA

There are on-cycle and off-cycle processes, and both differ in targeted applicants, timing, and interview:

  • The Off-cycle process: self-apply, usually for these situations – Middle Market funds recruiting Associate positions, Positions in non-US markets, and Positions for non-experience in Investment Banks 
  • The On-cycle process: right after you get into big investment banks (Bulge Brackets, Elite Boutiques) successfully, you are eligible for the on-cycle program, which is designed for IB analysts. After two years at investment banking, you can switch to private equity much more smoothly compared to candidates joining off-cycle. 

For further reading, you can check out our article about PE analysts and PE associates to learn more about the two processes. 

PE preferred people who came from Investment Banking as PE Analysts and PE Associates have to deal with plenty of financial modelings, or LBOs in the whole deal execution process. Of course, there are always exceptions if a candidate owns specific skills and knowledge that the firm is looking for, for example: an operational PE fund might look for experienced candidates in cleantech startups to manage its portfolio companies. 

5.3. Hedge Fund

The typical hedge fund career path begins 1 – 2 years post-college. Unlike large banks or asset management firms with comprehensive training programs, hedge funds are small, nimble operations with few resources to teach someone analytical finance from the ground up. Getting into a hedge fund straight out of college is difficult.

The traditional post-college career path to a hedge fund is investment banking, equity research, sales & trading. All are great at giving you a solid foundation in company research and financial valuation, which involves analyzing company and industry trends, modeling and forecasting, valuation, and presenting your ideas in a clear, succinct way.

The next most common career path to hedge funds is management consulting. Consultants would get the same fundamental skill set for hedge funds, but with more emphasis on company and industry analysis over financial valuation. If you come from the consulting background, just be extra prepared to sell your financial modeling skills going into a hedge fund interview.

If you come from a technical background such as engineering or medicine, your technical knowledge is particularly helpful to position you as an industry specialist (of course, you’ll still need a solid foundation in finance to have the chance of breaking in). For example, if you understand the nuances of a pharmaceutical company’s research pipeline and the FDA approval process, you have a leg up against others as a health care investor.

Quant hedge funds also hire many math, computer science, and engineering students who can program and build mathematical models for the markets.

Financial Modeling Program 

How to close the skill gap between formal education and becoming an Investment Banking Analyst

I want to know more!

6. Bottom Line: What to Choose?

Inevitably, someone will ask for a bottom line – “which industry is better?” Unfortunately, It’s not possible to say in absolute terms whether investment banking or private equity is the “better” profession. It depends on the type of work that you ultimately want to do and the lifestyle/culture and compensation that you desire. 

You can go into private equity if:

  • You want to work on long-term investments, and you like structure, process, and relationship-building.
  • You love building value for companies
  • You’re analytical, but you don’t like math enough to be a “quant,” and you want a variety of day-to-day work.
  • You are on the risk-averse side 

You can opt for hedge funds if:

  • You are extremely passionate about the public markets and investing, and you want to spend the bulk of your time coming up with ideas and making investments.
  • (For quant funds) You have a math, engineering, or computer science background, and you want to use it in a technical role.
  • You like regular, predictable hours and a consistent location with less frequent travel.
  • You don’t mind the random/unpredictable advancement process, and you can tolerate significant uncertainty.
  • You’re very certain that you want a long-term career in investing, and you have no interest in joining a normal company or doing something outside of finance.
  • You like playing with market volatility 

Join investment bank if:

  • You want to get exposure to a broader types of financial transactions (there’s a caveat – the breadth of exposure actually depends on your group)
  • You have good communication skills and are interested in doing financial modeling and valuations, closing deals, handling large transactions, and managing client relationships.
  • You like the structured hierarchy and advancement process and the career visibility that accompanies them.
  • You lack a clear vision of what to do in the long-term (investment banking provide broad exit opportunities)
  • You can sacrifice work-life balance and handle working 80-100 hours/week 
  • You don’t mind hours that fluctuate with deal activity as well as a decent amount of business travel.

 

Or, you don’t have to choose between the three, you can aim to do all of them. The most common pathway for those who work in these 3 industries is: 

Join Investment Bank as IB Analyst -> Join Private Equity as PE Associate -> Go for an MBA program -> Enter Hedge Fund as HF Analyst or Senior Analyst. 

Investment Banking Career Planning Tool