High Flying: A look at Hedge Fund Manager Pay

Originally posted April 2010

Reporters Nelson D. Schwartz  and Louise Story tell us in the March 31, 2010 article for the New York Times, “Pay of Hedge Fund Managers Roared Back Last Year” that: “… top hedge fund managers rode the 2009 stock market rally to record gains, with the highest-paid 25 earning a collective $25.3 billion, according to the survey, beating the old 2007 high by a wide margin.   The earnings figures reflect Absolute Return magazine’s estimation of each money manager’s portion of fees as well as the increased value of his personal stake in his fund.”

Hedge fund managers receive compensation in two ways.  First, managers receive an administrative fee – which may range from 1.5% to 3%, but generally equal  2% of total assets under management.  While at first blush 2% may not sound like much, but considering fund assets are measured in billions of dollars, 2% amounts to a significant amount of money.  The second way that hedge fund managers are paid is a performance fee.  Generally (but not always), hedge fund performance fees equal 20% of the gains realized by the fund.  Because this 20% is usually leveled on profits over a “high water mark” – the highest value previously reached by the fund – ensuring that the hedge fund manager and the investors are perfectly aligned, hedge fund performance fees are essentially the purest form of pay for performance.   Think of it this way, when the stock market is down, those fund managers who have lost less than the market decline are seen as “successful” (and, of course, as long as there are assets in their funds all these guys will get paid the administrative fee). Hedge fund performance fees don’t work that way.  Hedge funds must have year over year growth to pay a performance fee.  Hedge fund managers only get paid their performance fees if they make money for their investors.

But hedge fund managers are doing more than just making money for themselves and their investors.  For example, recently, Cerebrus bought Chrysler, saving tens of thousands of jobs.  In addition, they may also be taking on an activist investment role that can provide additional benefits.  Activist hedge fund managers acquired a substantial stake in the company and forced changes to improve corporate governance and better balance the governance power between boards and management.

The article “The Top 10 Activist Hedge Funds (to piggyback)” says with regard to activist hedge funds:

“1. They do enormous research to find out where there is hidden value. Activists typically go into situations where the value isn’t immediately clear and they press management to unlock that value (for instance, trying to get MCD to sell real estate holdings, etc).
2. They are typically long-term holders. Activists tend to take 5% or greater positions in a company. They aren’t able to nimbly trade out of those positions.
3. They usually publish their research in 13D filings in order to convince shareholders to vote their way.”

The article lists top activist funds as (among others):  Shamrock, Jana Partners, Carl Icahn, Chapman Capital,  and Third Point.

How, why and when hedge fund managers get paid is an important part of the fund structure and the hedge fund firm’s ability to retain its top talent.  Hedge fund principals would benefit from understanding the marketplace for talent. 
Towards this end, Grahall, has partnered with Holt Private Equity Consultants  and MM & K to create a groundbreaking survey, the “2010 Alternative Asset Management Compensation Survey”.  The survey collects and reports data on compensation design, as well as compensation levels; in other words, we will disclose both “how” compensation is paid, as well as  “how much” compensation is paid.

All information will remain confidential and survey participants will receive several free reports and other special discounts.  If you are interested in participating or want more information go to the survey home page or contact:

Grahall Consulting Partners, LLC
Claudia DeFrancisco, claudia.defrancisco@grahall.com, (617) 455-2307
Michael Graham, michael.graham @grahall.com, (917) 453-4341

Holt Private Equity Consultants
R. Michael Holt (Mike) , (239) 594-5530

MM & K Ltd.
Andy Manktellow, Andrew.Manktellow@mm-k.com,  020 7283 7200