Money is a lot harder to come by than it was this time last year, for rich and poor alike, and hedge fund professionals are feeling the pain like everyone else.
Pay is often tied to performance in the financial sector, and Alpha ’s third annual Hedge Fund Compensation Report leaves little doubt about the strength of that bond in the hedge fund industry. Average total compensation for all the hedge fund pros we surveyed was $794,000 in 2008 (down from $940,000 the previous year); cash bonuses were slashed, on average, by 24 percent; and prospects for a paycheck turnaround seem bleak.
[Click on the 2009 Hedge Fund Compensation Report for an in-depth look at the results of Alpha‘s survey of more than 800 professionals at nearly 550 hedge fund management firms.]
“A third of this industry is going away and not coming back,” says John Pierson, CEO of New York–based search firm 10X Partners, which funnels talent to and from many of the top hedge fund firms.
Last year was the worst on record for hedge fund performance — on average, funds were down 18.75 percent, according to Chicago-based data provider Hedge Fund Research. Rare today is the hedge fund that is not below its high-water mark. Add redemptions to the mix, and hedge fund assets have plummeted alongside performance, making it all but impossible for firms to maintain salary levels.
Key to the accompanying drop in compensation is the mechanism by which hedge funds derive much of their income. The traditional deal between fund and investor guarantees most managers a 20 percent cut of profits; that arrangement obviously no longer benefits managers, because most hedge funds are so far out of the money and will have to make up the losses before they start collecting performance fees again. Even management fees, typically assessed at 2 percent of assets, have been renegotiated lower in some cases. There is, simply put, less cash to go around, and fewer jobs too.
“It’s not like they got fired from one hedge fund and can just go to a fund down the road and get a new gig,” Pierson explains. “In the past the alternative would have been a proprietary trading desk at an investment bank, but there are very few such desks left now. For a lot of these people, it is over.”
Hedge fund firms are only now coming to terms with this new reality. Though their compensation pain is much less than that of Wall Street — where bonuses in most instances last year were down by more than half — hedge fund employees may be facing a lasting change. Alpha ’s survey of more than 600 professionals at single-manager and multistrategy hedge fund firms, from CEOs and partners to trading assistants and first-year associates, offers a harsh report on how fortunes have turned.
The results show a marked compensation drop over the course of one year for many hedge fund professionals, although not everyone saw a decrease. In 2008 the average total compensation for hedge fund CEOs was $1.9 million; in 2007 it was $2.4 million. The average total compensation package for a senior analyst last year was $867,000; the year before it was $1.1 million.
And as the recession continues to bite into the economy, hedge fund professionals are not optimistic about the year ahead. Case in point: In 2008 average pay for a senior portfolio manager was $1 million, down from $1.6 million the year before. The senior portfolio managers surveyed say they anticipate their 2009 total compensation, on average, to fall to $604,000.
The slide in compensation can’t be attributed solely to the falloff in hedge fund performance — it’s also a supply-and-demand phenomenon. Fewer funds are in business now; marquee firms, including New York–based Highbridge Capital Management and Fortress Investment Group, have cut staff; investment banks have had to dial back their operations; and suddenly once-in-demand employees are on the street.
This is perhaps the first buyer’s market for hedge fund talent, offering a sort of boon to downtrodden firms, which don’t have to pay as much because of the glut of applicants. The silver lining, if there is one, is that some firms are hiring. Pierson says that many of the biggest firms see the downturn as an opportunity to bring in fresh and better talent more cheaply than they could have in the past. Firms that are hiring include Chicago-based $10.7 billion Citadel Investment Group and $2 billion Balyasny Asset Management; $12 billion, Stamford, Connecticut–based SAC Capital Advisors; and $30 billion D.E. Shaw & Co. in New York.
“The competitive landscape for talent has changed significantly,” agrees Barry Colvin, vice chairman of Balyasny.
The reality is that, especially for junior staff members, hedge fund managers do not have to pay as before. That said — and although it’s all relative — survey results include some eye-popping numbers. One senior executive at a multibillion-dollar commodities trading advisor in the U.K. made more than $13 million last year.
A challenge facing many firms, especially big multistrategy ones that had bad years, is how to retain senior investment professionals. Many managers don’t have the cash to pay the big bonuses they gave such people in the past. Some firms, like $9 billion Maverick Capital in New York, have set aside reserves that include pools of bonus money (Maverick recently topped up its rainy-day fund).
Some firms are also paying a portion of employee bonuses in what are commonly termed “ghost shares” — equity that is tied to the value of the management company. Ghost shares can’t be accessed until after a certain amount of time; from a manager’s point of view, such compensation has the additional advantage of acting as golden handcuffs on key employees. New York–based, $2.3 billion Third Point is among the firms that have included ghost shares in compensation.
Alpha’s survey, however, suggests that substantial noncash bonuses are not an industrywide practice at hedge funds, as they are at the banks, and that by far the biggest portion of pay still comes in the form of a cash bonus. Nonetheless, in some cases, a firm will offer partnerships to outperforming investment professionals. Citadel has given equity like this to key employees in the past, but in 2008 — a year that saw its two flagship multistrategy funds fall by more than 50 percent — founder and CEO Kenneth Griffin did not part with any equity. (He did cover some bonuses out of his own pocket.)
Yet ownership remains the Holy Grail, even if it has become a little tarnished of late. For it is holding a partnership — owning a piece of the store — that makes hedge fund professionals richer than their Wall Street counterparts. The highest-paid people at hedge fund firms are typically managing partners. In 2008 the average managing partner at a hedge fund firm made $2 million, down from $2.2 million in 2007 — although managing partners who responded to Alpha’s survey say they expect to make just $1.3 million, on average, in 2009.
Many of the profits hedge fund executives have reported over the years have been plowed back into the funds, and as those assets have declined, so has personal wealth. Some hedge fund investors find parallels with the dot-com boom and with a popular Silicon Valley term — “vaporware,” for software that was mainly hypothetical but drew investor dollars anyway. All those hedge fund riches were vapor money.
Pierson, the New York–based headhunter, says that because of uncertainty across the industry, more and more hedge fund employees, even at the junior level, are seeking to be paid according to formulas that offer clear bottom-line guarantees. “No one wants to wait until mid-January to find out what their entire year’s work is worth, or have their pay be at the sole discretion of the managing partner,” he explains.
Most investment professionals surveyed say their bonuses are not guaranteed, though the majority say their pay is in some way tied to performance.
Among those who believe they have contract-assured, formula-based bonuses, some are finding out that getting paid may not be as easy as they thought. Todd Dittmann, a former managing director and credit investment professional at New York–based hedge fund D.B. Zwirn & Co., sued the firm in February, alleging that he had not been paid his full bonus from 2007. According to the complaint, Dittmann generated $74 million in profits for the firm in 2007, entitling him to a bonus of $3.2 million. But in March 2008 the firm said he was entitled to less — $2.63 million — and that he would be paid in three installments. The firm, which is winding down its $4 billion hedge fund after incurring heavy losses, declined to comment, but on February 13 a federal court in Houston denied Dittmann’s request for an order that would have frozen Zwirn assets pending resolution of the dispute.
During tumultuous times like these, some jobs become more important than ever — and potentially more lucrative. Chief compliance officer is one such position, given the duties that come with the job, including the management of counterparty risk. Also in demand are risk management officers, despite the slight reduction in their compensation in 2008.
One such executive, Mark Davies, the former head of credit at SAC, is now a risk management officer at Newport Beach, California–based fixed-income giant Pacific Investment Management Co. Davies’s move (he left SAC in June 2008 and joined Pimco at the beginning of this year) is among many that highlight the fact that traditional asset management firms are among the potential beneficiaries of the hedge fund slowdown.
“The migration from hedge fund to long-only asset management started to happen a few years ago,” says Philip Simons, an executive recruiter with NJF Search in New York who specializes in quantitative investment professionals. Rather than arriving with the potential stigma of not having been able to hack it in the hedge fund world, switching to a more conventional investment sector now “can look like the smart move,” he adds.
