Hedge Fund Comp: All About the Back Office

Many hedge funds, particularly those focused on equity strategies, struggled to generate returns in 2014, although a continuing flood of new capital helped cushion those difficulties, at least in terms of compensation. Senior hedge fund professionals didn’t see quite as much of a bump in pay last year as they had in higher-performing years, and some even experienced deep cuts. However, noninvestment professionals, a group that rarely gets much attention, saw significant increases year over year, according to the 2015 Hedge Fund Compensation Report by Institutional Investor’s Alpha.

Overall, 2014 was a tough year for many hedge fund firms. Nearly 500 closed in the first half of the year, and the trend continued throughout 2014 as equity investors found it difficult to beat the high-flying S&P 500 and macro traders stumbled with bets upended by black-swan events, from the lifting of the ceiling on the Swiss franc to plunging oil prices to a world awash in central bank quantitative easing.

“When I ask portfolio managers what’s the best thing that could happen to them this year, they say it would be for the S&P to not rise so much,” says Jessica Lee, a director at New York–based executive search firm Options Group. “It’s a big challenge to explain to investors why you’re lagging in performance.”

Poor returns can result in a big hit to the paycheck. In 2014 total pay for senior hedge fund investment professionals dipped, with total mean compensation for all job titles falling 12 percent, to $811,145, from 2013’s $922,218. But the chief executives and chief investment officers surveyed by Alpha saw their pay drop by more than 30 percent, on average. This could reflect the extreme highs and lows that many firms experienced with the return of volatility in some market segments and frustrating stagnation in others last year.

However, certain noninvestment jobs experienced the opposite trend. Operations officers, controllers and general counsels surveyed by Alpha saw total compensation increase 9.2 percent, 7.5 percent and 2.3 percent, respectively. These numbers reflect the continuing expansion of products and services offered by hedge fund firms, as well as increasing regulation, says Kenneth Heinz, president of Chicago-based Hedge Fund Research.

“It’s a function of the growth and maturity of the hedge fund industry as a whole,” he says.

Hedge fund firms have come a long way from their early incarnations; many are now full-service investment complexes with traders, portfolio managers and back-office staffs that include marketing, investor relations, business development, legal services, compliance and technology. The firms’ standards for noninvestment professionals’ skills and backgrounds are high, and many in the industry report that competition for a limited pool of qualified candidates is stiff — and expensive.

One reason standards keep rising is the changing character of hedge funds’ investor pools. Assets from institutional investors make up a larger proportion of hedge fund capital than ever before. By some estimates, some $2 trillion in institutional money has flowed into hedge fund firms since 2002, edging aside more-traditional investors such as wealthy individuals. Those institutional investors, especially pension funds and family offices, have specific demands that often go beyond simple performance.

“The investor base has shifted to more-sophisticated investors that have a standard process and expect a certain level of transparency,” Options Group’s Lee says. This process boils down to a greater focus on disclosure: how hedge fund firms report, how often they report and how accurately they report. Institutional investors demand transparency and consistency that only professional marketers, operations officers and other noninvestment professionals with pedigree and training can provide.

“‘Transparency’ is the buzzword of the day, and that costs money,” says Robert Olman of Manhasset, New York–based Alpha Search Advisory Partners. He notes that the traditional strategy of paying someone “$1 million for $1 billion” in new capital has been abandoned as firms try to figure out how to effectively compensate noninvestment professionals. This change has been most obvious at smaller hedge fund firms.

“Over the past four to five years, the fiduciary requirements have changed so much, to the point where pension funds are using consultants much more to safeguard their investments,” says Sasha Jensen of New York–based executive search firm Jensen Partners, which publishes its own compensation survey focused on marketing and investor relations. “Salespeople who have the relationships with consultants are in demand because hedge funds need someone who knows how to run the [institutional-investor-specific investment] process” in the way pension funds and other institutional investors demand.

This call for skilled employees, and the expense of hiring and compensating staff with the right experience, have proved challenging, particularly for newer funds, over the past few years. “The smaller funds are waking up to the fact that they need a family-office marketer, a head of consultant relations, a head of institutions,” Jensen says. “Some can’t afford to do that, but they’re working on it.”

Not only are transparency standards higher and regulatory demands greater, there are more technological tools required to help manage risk, liquidity and leverage. These tools need to be developed and maintained by specialists who are also in great demand across finance, and beyond.

And, recruiters say, it may be difficult to persuade these professionals to work for hedge fund firms. The risk of a hedge fund is often perceived as being much greater than that of, say, a tech giant like Google or Apple, and many candidates are concerned about how the jobs would advance their careers. Although many hedge funds have built their strategies around technology, others are only now getting into the game; where a firm stands on that spectrum plays a big role in its success in attracting skilled professionals. The best way to get around this, recruiters say, is compensation.

“From a lifestyle perspective it’s very tough to attract technologists or high-level analytics people to work for a hedge fund or bank versus a tech company,” says Options Group CEO Michael Karp. “There’s a war for talent across industries and firms have become very competitive when recruiting these professionals.”

That’s true even for technologists and marketers already working at hedge funds, says Karp. He notes that when those potential hires want to move, they are increasingly snarled by tough noncompete clauses, some of which tie up professionals for as long as 18 months.

“Noncompetes are becoming as onerous [at hedge funds] as they are in the tech world,” Karp says. All this not only hikes the cost of recruiting but raises the final price.

At the same time, most funds appear to be able to afford relatively high executive pay, even in the face of less-than-stellar performance. Experts note that despite mediocre returns over the past several years, and with the exception of some big cutbacks like those picked up in Alpha’s survey, there has not been broad downward pressure on compensation. Like the push to pay up for the best noninvestment staff, this can be attributed to the rise of institutional investors as clients and the inflows of capital they provide. Many funds still operate using some version of the 2-and-20 system, in which a flat 2 percent fee on assets under management can generate significant annual income even during less-than-inspiring years.

“Many pension funds and endowments will continue to give money to managers with risk-adjusted returns — stable, low-volatility returns,” says Anthony Keizner, who heads the hedge fund practice at New York–based Glocap Search. “That’s why in a year like 2014 you saw very few instances of compensation radically decreasing.”

— Kaitlin Ugolik

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