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ome hedge fund managers are taking salaries, private-jet expenses and entertainment costs directly out of the funds they manage, according to investors and consultants.

Hedge funds notoriously charge high upfront fees, with the “2 and 20” model of a 2 per cent annual management fee and 20 per cent performance fee the historic norm.

Despite this, some are charging their costs and expenses to the funds they manage, eroding investors’ returns still further.

“We have seen some very bad examples, such as hedge funds paying salaries from the funds and private jets put through the fund expenses,” said Ed Francis, head of investment for Europe, the Middle East and Africa at Towers Watson, a consultant. He described these charges as “pernicious”.

“This is certainly very true of some of the larger established funds. They would put salaries and expenses through and that was pretty normal,” said a former fund of hedge funds manager, who declined to be named. The manager estimated the cost of such charges as around 30 basis points a year.

Phillip Chapple, executive director of KB Associates, an operational consultancy, said other hedge funds were charging marketing expenses, data fees and the costs of Bloomberg terminals and research directly to funds.

“I think a lot of managers see this as a way of eating up expenses that they incur as a fund manager,” he said. “It is very hard to look people in the eye and justify some of that stuff. If you find them doing this, then you wonder what else they are doing.”

The charges are legal if they are outlined in a fund’s offering memorandum or private placement memorandum. However, these documents are “typically written in a way to encompass most things imaginable”, according to Joshua Barlow, associate director at Paamco, a fund of hedge fund manager.

Many charges, such as those for audit fees, legal fees, administration costs and tax filings, are widely seen as legitimate.

Mr Barlow said he had seen “surprising” levies for “employee salaries, technology, regulatory filings, fund portfolio and accounting systems, outsourced middle office, insurance, trade errors, travel and entertainment” that, in some cases, are “so large that they raise the question ‘what is the management fee I am paying going towards?’”

“We have seen instances where they can be quite large,” said Stephen Oxley, managing director of Paamco. “They might say they need to use an executive jet to visit a company, but that doesn’t cut any ice for us. We have it in our sub-advisory agreements that we are not going to pay. We are not going to invest unless this is sorted out.”

Mr Francis said the most egregious abuses were being weeded out amid a greater focus on operational due diligence, as institutional investors increasingly replace wealthy individuals as the primary hedge fund investors.

Some allocators to hedge funds said they were willing to invest in the worst offenders if their performance was sufficiently good, while others admitted they did not have the resources to check exactly what they were being charged for.

“The onus is on the investor to understand what they are invested in [but] it is slightly hidden in the documentation. We had to go digging for it,” said the former fund manager.

Jack Inglis, chief executive of the Alternative Investment Management Association, said: “Managers disclose all fees and expenses that are directly or indirectly borne by investors.”

“We expect that the professional nature of hedge fund investors allows them to fully assess the appropriateness and the level of such fees prior to and during the life of their investments.”

- Report noting this "could put France's budget in 'serious noncompliance' with the new EU rules, likely leading the commission to send it back to Paris for revisions."

- EU official: "What people underestimate is that what's at stake is the entire credibility of the rules."

--> The Bottom Line

Micron’s earnings per share are growing at a double-digit rate, but shares, at $33.94, trade at just nine times earnings–well below peers. At 12 times, they would be worth $50 in a year.

Makers of DRAM have been winnowed to three players. Market forces could push Micron Technology stock higher.

Computer memory is in fierce demand, and prices are riding high. That puts memory makers in an excellent position, which, using the upside-down logic that investors have learned to apply to the group, should be cause for concern. Plump profits have historically tempted manufacturers to overproduce, leading to bloated inventories, tumbling prices, and the next bust for shares.

In a report this past week, tech forecaster Gartner said that dynamic random access memory, or DRAM, the main working memory for computers, should generate 26.3% revenue growth this year, for an all-time high of $44.1 billion. That helps explain how shares of DRAM specialist Micron Technology (ticker: MU) have multiplied from $6 to $34 in just two years. But in the same report, Gartner warned that 2016 will bring—marvel at the precision—a 25.5% revenue plunge. And that explains why Micron stock, despite its run-up, is pessimistically priced at nine times projected earnings for the next four quarters, substantially below its peer group and a 40% discount to the Standard & Poor’s 500 index.

Investors should buy the shares. There are reasons to doubt the good-news-is-bad-news investment logic this time around. Chief among them, the number of key DRAM makers has collapsed from more than 20 in the 1990s to three today. That has created more discipline on supply. So has the rising difficulty of shrinking memory chips. Meanwhile, DRAM demand, which has benefited of late from surprisingly strong orders to refresh workplace computers, should get long-term support from the growing computational needs of smartphones and data-crunching applications. None of this will bring an end to memory cyclicality, but it should provide steadier cash flows, leading to less-fearful stock valuations. Over the next year, that could send Micron shares up nearly 50%.

Based in Boise, Idaho, Micron has an estimated 25% to 30% DRAM market share, tied for No. 2 with SK Hynix (000660.Korea), behind leader Samsung Electronics (005930.Korea). It also has a 10% to 15% share of the market for flash memory, or NAND, used for data storage with speedy access. That market has five suppliers, with Micron and SK Hynix vying for fourth behind Samsung, Toshiba (6502.Japan), and SanDisk (SNDK).

In the industry shakeout that has occurred since the 1990s, Micron survived early on not by staying ahead on technology but by staying a step behind. While Japanese rivals spent fiercely at the cutting edge, Micron “bootstrapped its way up,” using slightly older machines to produce slightly lower-spec chips, with a focus on profits, according to Rick Whittington, who covers the stock for Drexel Hamilton. Now Micron has become one of the cutting-edge players, thanks in part to a joint venture with Intel (INTC) on NAND and the purchase last year of Japan’s Elpida, a mobile DRAM specialist, out of bankruptcy.

In its fiscal year ended on Aug. 28, Micron reported profit of $3.05 billion on revenue of $16.36 billion, up 156% and 80%, respectively, from the year before. Including a raft of one-time items partly related to acquisitions, profit jumped to $3.74 billion from just $247 million. Adjusted earnings per share were $3.23, up from 24 cents. DRAM fetched about two-thirds of revenue and NAND, most of the rest. Wall Street expects EPS to climb at double-digit paces in Micron’s newly started fiscal year and the next one, hitting $3.68 and then $4.09.

PERSONAL COMPUTERS STILL drive 40% to 50% of DRAM memory demand, and with Microsoft (MSFT) discontinuing support for its Windows XP operating system earlier this year, companies have been forced to upgrade, prompting new machine purchases. In July, Intel cited enterprise PC purchases as a leading contributor to a 40% profit jump. Investors have found plenty of reasons to contain their optimism.

Apple’s (AAPL) new iPhone 6 uses the same single gigabyte of DRAM as previous models, a disappointment to those who expected more. Analysts say Apple’s memory stinginess is a reflection of tight industry conditions and its efficient operating system. But other smartphone makers, including Samsung, continue to add memory.

One lasting change is rising demand for big-data applications, which companies can use to turn information into selling opportunities. Those require vast amounts of memory to generate real-time results as customers make transactions. In a recent note to investors, Credit Suisse called big data the most important incremental driver of its bullish view on memory, and one that investors are missing with their focus on supply. It sees Micron as significantly undervalued, trading at an enterprise value (stock market value plus debt, minus cash) of just 1.3 times the replacement value of its manufacturing assets, versus more than two times for rivals.

NAND memory, meanwhile, is expected to continue gradually replacing mechanical hard drives due to its faster access speeds and lower power consumption. While supply there isn’t as tight as for DRAM, memory makers are running up against the laws of physics in trying to cram more storage into smaller spaces, forcing new, expensive approaches, like 3-D transistor architectures that build up rather than just out. Micron’s partnership with Intel gives it access not only to leading chip designs but also to new alloys, and Intel is motivated by its view of chip rival Samsung as a bigger threat, says Drexel’s Whittington. That partnership alone over the next few years could be worth $10 a share on top of the stock’s current price, he estimates.

Beyond technology, Micron’s Durcan views service as a key competitive advantage. “We’re a global company with deep customer relationships, whereas many of our competitors are more nationally focused,” he says. “That’s important in a world where you’re trying to not only deliver something but also help customers integrate it into their systems.”

ALL TOLD, RISING memory demand should continue to meet restrained supply in coming years, and to the extent manufacturers are tempted to relax their discipline on supply, new, more difficult chip advances should keep them in check. That should result in rising cash flow for the group. Jefferies & Co. predicts free cash flow for Micron will swell to $3.4 billion this fiscal year from $2.6 billion last year, for a free cash yield of more than 9% at the stock’s current price.

A rise in the stock price to $50 over the next year would put Micron at 12 times forward earnings estimates, still a 20% discount to the broad semiconductor group, which includes processor and equipment makers. It’s a valuation that acknowledges memory’s continued exposure to swings in the economy, but also recognizes that the group’s wildest swings in profitability are likely behind it.

Faith in austerity is falling as geopolitical tensions are rising. That bodes well for the region’s neglected defense stocks.

European governments are losing faith in austerity just as geopolitical tensions are rising, factors that bode well for the region’s neglected defense stocks. Investors have largely steered clear of defense companies on fears that spending cuts would constrain earnings. Figures compiled by the International Peace Research Institute, or Sipri, show that worldwide military expenditures fell 1.9% in 2013 and 0.4% the year before.

That decline was driven mainly by the U.S., the world’s biggest defense client, which cut spending 7.8% last year. Strip out the U.S. and spending would have risen 1.8%, boosted by countries such as China, Russia, and Saudi Arabia. Sipri attributes the U.S. decline to the end of the Iraq war, the start of the Afghanistan drawdown, and effects of congressional budget cuts in 2011. Defense spending also fell more than 2% in Western and Central Europe last year.

Now there are signs that the declines are reversing. Despite cuts, spending still amounted to a whopping $1.75 trillion in 2013. The U.S. has been drawn back into conflicts such as attempts to contain the Islamic State. And there are concerns about renewed terrorist activity.

Even Germany, which spends about 1.3% of its economic output on defense, compared with 4.4% in the U.S. and 1.9% in France, according to the North Atlantic Treaty Organization, may have to open its wallet. A German parliamentary report leaked last week gave a shocking view of its military, in which only a handful of helicopters and armored vehicles are operational.

Meanwhile, austerity critics are gaining ground. France’s ruling Socialist Party presented its 2015 budget this week outlining cuts that fell short of those promised by President François Hollande when he took office over two years ago. Finance Minister Michel Sapin said France would “refuse austerity.”

Tim Gregory, head of global equities at London’s Psigma Investment Management, says he hasn’t owned defense stocks for several years. “From an investment perspective, because of budget constraints and the impact of austerity on spending, investors have steered clear of the sector.”

As a result, many defense stocks have underperformed the European equities market and would react to even a slight uptick in spending. Although not ready to buy back into defense, Gregory says one prospect is Ultra Electronics (ticker: ULE.UK), a United Kingdom aerospace and defense business. “It has very high-quality management and manages its capital well. It’s about 50% defense but also has cybersecurity, which is a good area to be in right now. Around two-thirds of its defense activity is in naval, tactical sonar systems,” he says.

BESI Research analyst Edward Stacey this week upgraded the stock to Buy from Neutral. He gives the share a prospective fair value of 20.50 British pounds ($33.12), with upside potential of 19%. The stock closed on Friday at €17.51.

Spanish defense and transport company Indra Sistemas (IDR.Spain) could benefit from Madrid’s 2015 draft budget, which kept defense outlays steady. Kepler Cheuvreux’s Natalia Bobo says, “In 2013, the defense budget was down by 2.3%; thus, at least, we are seeing some stabilization.” She has Indra as a Hold with a 12 euro ($15.20) target price. The stock closed on Friday at €10.83.

Cover story: Highlights two fund managers at Fidelity with two separate approaches. 1 who chooses stocks he feels will double earnings in 5 years, the other who chooses stocks under $35/shr that look undervalued with strong cash flow. Discusses the environment for passive vs active investing and the potential for the pendulum to swing back to active investing as interest rates normalize and correlations among stocks start to break down. 

Split Would Separate PC, Printer Operation From Corporate Hardware and Other Units

Hewlett-Packard Co. HPQ +2.00% plans to break in two, separating its personal-computer and printer businesses from its corporate hardware and services operations, according to people familiar with the matter.

The company plans to announce the move as early as Monday, the people said. It is expected to be effected as a tax-free distribution of shares to the company’s stockholders next year, one of the people said.

The move is one H-P and its investors and analysts have long contemplated. It would come amid a wave of breakups and spinoffs at technology companies and in the wider corporate world, underpinned by the idea that companies with a narrower focus perform better. The moves in many cases have been well-received by shareholders—if not actively sought by them.

Last Tuesday, online-auction pioneer eBay Inc. EBAY -0.77% announced a plan to spin off its PayPal payments-processing unit. Shareholders rewarded eBay’s decision, pushing the company’s shares up about 7.5% that day.

This isn't the first time H-P has come close to a decision to hive off its sprawling PC operation. In 2011, when it announced the ill-fated acquisition of U.K. software company Autonomy Corp., H-P said it was exploring a separation of its PC business. Under pressure from shareholders that led to the departure of then-Chief Executive Léo Apotheker, H-P reversed course two months later and said it would hold on to the business.

In 2012, under current H-P CEO Meg Whitman, H-P reorganized itself to combine the PC business with its more profitable printer operation.

Ms. Whitman will be chairman of the PC and printer business and CEO of the separate, so-called enterprise company, one of the people said. Current lead independent director Patricia Russo will be chairman of the enterprise company, while Dion Weisler, an executive in the PC and printer operation, is to be CEO of that business, this person said.

In fiscal 2013, the printing and personal systems group, as it is known, inked $55.9 billion in revenue, about half the Palo Alto, Calif., company’s total. Sales for the operation dropped 7.1% amid fierce competition, compared with a 6.7% decline for the company as a whole.

Last year, H-P lost its place as the largest PC maker by shipments, slipping to No. 2 behind China’s Lenovo Group Ltd, according to industry research firm IDC.

H-P, famously founded in a garage in Palo Alto 75 years ago, has been undergoing a multiyear restructuring under Ms. Whitman as the company tries to stem sales declines. Aside from the PC and printer business, the rest of H-P’s revenue comes from selling services and hardware such as servers and data-storage systems to corporations, as well as software and financial services.

H-P’s shares have risen sharply since last year, but are still well below their highs in recent years—and the even loftier levels they reached in the 1990s tech boom. H-P shares increased 2% Friday to $35.20, giving it a market capitalization of nearly $66 billion.

To combat lower sales and provide lift to its shares, H-P has laid off tens of thousands of employees and cut other costs.

Ms. Whitman has sought to push H-P further into growth pockets such as cloud software, but the company has struggled to make headway in such areas.

H-P has also been contemplating big strategic changes lately. Over much of the past year, the company held talks to merge with data-storage giant EMC Corp., but those negotiations, which would have created an industry giant with a market value of roughly $130 billion, recently ended, The Wall Street Journal has reported.