Where the Money Is

Last year was tough for many investors, but many hedge fund professionals saw their compensation soar in our second annual survey. By Imogen Rose-Smith Any number of economic indicators are down, all hampered by the global tide of debt gone bad, but you wouldn't know that by looking at hedge fund paychecks. Many managers have done just fine, and some have profited enormously from the collapse of the U.S. subprime mortgage market一most notably, John Paulson of New York-based Paulson & Co., who earned $3.7 billion in 2007- though making money has gotten more difficult as banks that were caught holding troubled subprime paper have reduced lending to hedge funds.

Indeed, credit markets were in their fifth month of turmoil when Alpha conducted the survey for its second annual Hedge Fund Compensation Report early this year, and the results一as might have been expected 一reflect a widespread glumness about paydays to come. Yet even in the hard times that began late last summer, many managers did reasonably well, though the subsequent spike in volatility and market extremes have fueled extremes in compensation, too.

Our survey of more than 800 people at nearly 600 hedge fund firms sometimes investment in 27 countries finds that pay varies widely and incredibly. Compare, for instance, the chief officer at a small East Coast hedge fund with a particular senior analyst at one of the firms on the Hedge Fund 100, our ranking of the world's biggest single-manager hedge fund firms. The CIO took home more than $25 million last year; the senior analyst made just $150,000. Year-to-year changes in some cases arc breathtaking too. Consider one Europe-based CIO whose pay dropped to $240,000 in 2007 from $11.9 million in 2006

Why the variability? Hedge fund economics have a lot to do with it. Managers have plenty of money to go around in good years because of the rich fees they charge一typically a I to 2 percent management tee and a 20 percent performance fee一and the relatively low overhead required to operate their businesses. Bad years, however, can be devastating, especially because most funds apply high-water marks, meaning that managers must make up for losses before they start to collect performance fees again. If a hedge fund suffers substantial losses, it can he all but impossible to get back to the level where it can charge 20 percent again, and managers may be required to reach into their own pockets to pay employees or risk losing them.

The liquidity crunch and deleveraging of the markets have not played out fully, and many hedge fund managers think compensation will take a hit this year.

"I expect, as an industry, comp will be down," says Barry Colvin, vice chairman of $1.5 billion Chicago-based multistrategy hedge fund firm Balyasny Asset Management. "We have a rough year一。go."

By this time last year, Colvin points out, many funds were reporting strong early results, and一even with the volatility of late summer - they did make money in 2007. The outlook has changed.

In our survey we asked a broad range of professionals 一everyone from marketing associates and junior traders to chief operating officers and CFOs一how their 2007 compensation stacked up against what they made in 2006, as well as their expectations for 2008. The responses show a general resignation to the likelihood that their pay this year will drop. On average, CEOs expect a 32 percent cut in compensation and say their 2008 bonus will be offby about 38 percent from last year. ClOs responded similarly, expecting their bonuses to be down, on average, by 45 percent and their total compensation by almost 39 percent.

The troubles in the credit markets actually proved a boon to some hedge funds last year. Brian James, former co-head of Fixed income at New York structured credit firm Cohen & Co. and now a founding partner with Link Global Solutions, a New York-based recruiting and consulting firm, says many funds were on the right side of the meltdown. "Even within structured credit we saw people making a lot of money last year, more than they did in 2006." James explains. "In credit generally, the funds that didn't blow up experienced a lot of upside."

Even as the likes of hedge fund titans Steven Cohen, Kenneth Griffin and James Simons added substantially to their already vast wealth, many little-known employees did well, too. The $24 billion London-based hedge fund firm GLG Partners, which went public on the New York Stock Exchange last year, reported in its annual earnings statement that it paid $810 million in employee compensation and benefits, up from $168 million in 2006. The firm's 349 employees include 125 investment professionals.

Public filings from Sloane Robinson, a $15 billion London-based hedge fund firm specializing in emcrging markets, show the beauty of hedge fund economics. In its fiscal year ended March 2007, the firm made about $400 million, mostly from its 15 percent performance fee (it charges a 1 percent management fee). Just over $4 million of that $400 million went to overhead, and most of the rest was divvied up among Sloane Robinson's 14 limited partners. But had the firm broken even or lost money, there would have been no riches to share.

According to the 2008 Alpha Hedge Fund t.;ompensa Lion Report, CEOs, on average, earned $3.8 million last year, up sharply from $2.5 million in 2006. The median CEO total compensation for 2007 was $1.3 million, up from $878,000 in 2006. Roughly one quarter of the chief executives who responded to our survey earned $10 million or more; 41 percent earned $500,000 or less. Wide disparities in compensation are equally common for ClOs, who are usually the second-best-paid hedge fund executives. The average 2007 total pay of ClOs we surveyed was $3.6 million, a 45.6 percent increase over 2006, with a median compensation of more than $1.0 million, up from $725,000.

Overall, investment returns in 2007 were every bit as scattered as compensation. Chicago-based data provider Hedge Fund Research's fund-weighted composite index was up 10.0 percent, but individual strategies within the index varied from a 0.7 percent loss for fixed-income funds that invest in corporate bonds to a positive return of 25.0 percent for emerging-markets funds. The range for individual hedge funds was much broader, thanks in part to the relentless credit tightening.

"There was a wide distribution of performance last year," notes Philip Simon, an executive recruiter for Long Ridge Partners in New York who works with a number of big hedge fund firms. Some brand-name funds were down, among them Goldman Sachs Asset Management's Global Alpha fund, which fell 38 percent, and Tudor Investment Corp.'s Raptor Global Portfolio, which was off 8 percent. But other firms had stellar years, including Maverick Capital, whose flagship fund was up 27.5 percent, and Viking Capital Management, whose main find soared 40.4 percent.

Because hedge fund compensation is tied to pcrformance, most of it comes in the form of cash or equity bonuses. The typical senior portfolio manager last year received base pay of $372,000 and a $2 million bonus. Senior portfolio managers, however, expect their bonuses this year to be $1.6 million on average, a sure sign that market cxpectations for 2008 are not promising.

But not everyone was glum about the year ahead. Investment professionals with expertise in distressed securitics say they expect their compensation to increase over 2007's. Experts in directional fixed-income trading and risk arbitrage are also upbeat. Maybe they should be. Several new hedge funds have been created lately一and some established ones are hiring people一in hopes of taking advantage of underpriced debt in the mortgage and structured-credit markets. New York-based Fortress Investment Group ($50 billion in assets under management), for example, is hiring a structured-credit team, headed by Joseph Walsh from RBS Greenwich Capital in New York, and plans also to create a new distressed fund.

Link Global Solutions' James says that many of these firms are luring sell-side talent, offering low base salaries but a higher-than-usual percentage of profits一as much as 10 percent for an individual on the return from his or her portfolio. "Many people are jumping at that," he adds.

Wall Street proprietary traders have historically been reluctant to join hedge fund firms as employees rather than as partners because they fear being left short on the compensation pie. They may have reason to be concerned: Ownership matters. Median total compensation for a managing partner at a hedge fund firm in 2007, according to our survey, was $1.2 million. For a director it was $357,000.

"People on a proprietary trading desk at an investment hank can make at least as much money as they would in the same role at a hedge ft且nd if theyare not a founder," says Adam Zoia, founder and managing partner in charge of the hedge fund and private equity business for recruiting firm Glocap Search in New York. Since last fall, layoffs have been rampant at Wall Street investment banks, however, and unemployed talent abounds.

But there are still hedge fund jobs to be had. Lynn Tidd, a partner at executive recruiting firm Russell Reynolds Associates, says a marketing director with 15 to 20 years ofexpericnce at a top-tier hedge fund firm can expect to earn 15 to 50 percent more than a counterpart at a traditional long-only asset management shop. Debra Brown, another Russell Reynolds partner, puts base salaries for traditional money management marketing executives in the $200,000 to $350,000 range and says hedge fund counterparts have comparable base salaries but can earn far more in bonuses.

Rank-and-file hedge fund employees can certainly do well, too. The average associate last year made $277,000, though one at an activist fund who responded to our survey earned nearly $1.4 million, of which $1.2 million was a cash bonus.

Simon，the Long Ridge recruiter, says many hedge fund firms have overhauled their compensation guidelines in recent years to stay competitive. Managers have tended to take one of two approaches, which helps explain the extremes in pay. The first strategy is to move toward paying discretionary bonuses based mostly on overall fund performance but secondarily tied to individual investment team results. The second is a more eat-what-you-kill scheme based almost entirely on individual performance, which is best associated with firms like the Stamford, Connecticut-based SAC Capital Advisors ($16 billion in assets under management). Such arrangements can be lucrative: SAC charges a pcrformance fee of as much as 50 percent for some funds.

Midlevel investment professionals are likely to be better compensated at Hedge Fund 100 firms than at smaller shops. The average total pay for a senior analyst at a Hedge Fund 100 firm in 2007 was $1.3 million; at smaller outfits it was $824,000.

The difference in pay at big and small firms is even starker for those in jobs that are not involved directly with investment. Hedge Fund 100 marketing directors received, on average, a total compensation package of $3.6 million in 2007. The average at other firms was $801,000. This could be a tough year for hedge fund professionals of every stripe. Colvin, the Balyasny vice chairman, predicts fewer institutional dollars will flow into the industry. "I expect the spigot will he turned off," he says.

But a bad year doesn't always stop a firm from trying. D.B. Zwirn&Co., the New York-based hedge fund operation that said in February it would close its two main funds after investors pulled more than $2 billion, is already out raising a new fund. It's a classic retrenching that illustrates what drives hedge fund compensation. The two funds were so far below where they needed to be to earn the all-important performance fee that rather than trying to scrape back, it was easier just to admit defeat and start all over again.