Hedge Fund D.E. Shaw & Co to Change Its Fee Structure

Case Type: business competition/competitive benchmarking; improve profitability.
Consulting Firm: Capital One 2nd round job interview.
Industry Coverage: financial services.

Case Interview Question #00320: You are consulting to D. E. Shaw & Co., a global investment management firm based in New York City, New York, United States. The company is best known as a hedge fund that makes extensive use of quantitative technologies and qualitative trading strategies to manage its investments. The firm’s trading mode is systematic and computer-driven. The company also makes private equity investments in technology, wind power, real estate, and financial service firms and in distressed company financing.

The client D. E. Shaw & Co. provides investment management and financial advisory services to institutional clients, financial intermediaries, private clients, and investment vehicles around the world. Clients must invest a minimum of $1,000,000. This money will be invested by the client’s personal portfolio manager in stocks and bonds such that the portfolio created is in line with the client’s personal goals. The price they charged for portfolio management is 1 basis point plus an annual fee. The firm recently benchmarked other hedge funds and investment management firms. They found that their profitability was lower than the competition. What would you recommend the client to do to regain competitive advantage?

Possible Answer:

For this profitability and competitive benchmarking case, it is totally OK to know nothing about hedge fund or investment management, just go ahead and ask the interviewer relevant questions. Remember, it is not a good idea to BS your way through and get stuck along the way!

Candidate: What is a basis point?

Interviewer: One basis point (bp) equals 1/100 of 1% of the invested amount. Put another way: 1 bp = 0.01%.

Candidate: How do hedge funds and investment management firms compete?

Interviewer: Level of service, performance, some on price.

The basic profitability framework is helpful here: Profits = Revenues – Costs = Price * Volume – Costs. I structured my questions around this equation.

Candidate: How does our client’s level of service, performance and price stack up versus the competition?

Interviewer: Our client’s service and performance is comparable to the competition, but their price is lower than the competition.

Candidate: How do our client’s costs compare to the competition?

Interviewer: The key components of the cost structure are real estate (office building), technology costs, and salaries; they are all in line with the competition.

Candidate: What is our client’s investment base relative to the competition?

Interviewer: The investment base is comparable to other firms, but magnitudes smaller than the big investment management firms.

Candidate: What would it take to increase our client’s investment base?

Interviewer: You could probably marginally increase your investment base without much investment, but to significantly increase it you would have to invest significantly (spend heavily on recruiting, hire experienced portfolio managers away from big firms, increase advertising, etc.)

Recommendations for client:

After exploring all of the angles of the profitability equation, I concluded that changing our client’s fee structure and raising the client’s price (at least to competitive levels) would positively affect client’s bottom line. It turned out that a price increase would not negatively impact client’s investment base.