How top hedge funds can pay traders $100mn
The era of giant multi-managers has changed how rewards are calculated — and ushered in bumper deals
Even for the hedge fund industry, $100mn is a lot of money.
That was how much Izzy Englander’s Millennium Management had to offer to convince Steve Schurr — a senior portfolio manager (PM) at New York-based Balyasny, and the Financial Times’ former hedge fund correspondent — to defect earlier this year.
“It’s a great trade for Schurr Capital,” said an executive at one of the largest global hedge funds.
This is how a select group of hedge funds known as the multi-managers — chief among them Balyasny, Citadel, Millennium and Point72 — created new cost and incentive structures, and rocketed trader pay into the nine figures.
These illustrations are simplified examples based on conversations with more than a dozen multi-manager executives, portfolio managers and recruiters in the industry.
In the past decade, the multi-managers have scooped up the world’s top portfolio managers across every type of trading strategy. The biggest now have hundreds of portfolio managers, each entrusted to run their team — or “pod” — like their own small business with their own income statement.
Key to their success is a new fee model. The traditional set up was “2 and 20”: a management fee equal to 2 per cent of assets a year covers costs, and a performance fee worth 20 per cent trading gains. Portfolio managers got a cut of the profits they make, but usually less than the 20 per cent performance fee.
The problem is that a single year of mediocre performance could prove an existential crisis for the fund. Poor performance from some portfolio managers limits the firm’s ability to pay its best people, a problem known as netting risk. Competitors then pick off disgruntled stars, leading to a downward spiral that can sink the fund.
“If they have bad performance then the good people leave and it gets worse and worse,” said one hedge fund recruiter. “You hear about people getting shafted when they are paid a fraction of what they are supposed to get.”
In the multi-managers’ “pass-through” fee model, investors instead cough up almost all the hedge fund’s expenses, including bonuses for portfolio managers, client entertainment and technology. This structure in turn allows the portfolio managers to keep a far higher proportion of what they make. Profit shares can go as high as 40 per cent, though 15-20 per cent might be more typical.
In this example, we take a portfolio manager (PM) who has been allocated $5bn and has negotiated a deal where they get a 20 per cent profit share.
This model addresses both big talent retention problems faced by traditional hedge funds. If a hedge fund has a poor year it can charge the winnings owed to the few top performing portfolio managers directly to investors, preventing them from leaving. This may anger investors in the short run, but key talent can be retained to fight another year.
And if the opportunity to hire a top performer comes along, the firm can snap them up without worrying about short-term profitability. The netting risk has been pushed from the management of the hedge fund on to investors.
To persuade top portfolio managers to switch firms, however, the multi-managers have to dangle additional incentives. These will be negotiated heavily, and are highly customisable. Some elements are one-off payments, others can help turbo-charge a portfolio manager’s earnings for years after they make a move.
This is how a portfolio manager secures an offer that gets them to $100mn — and beyond.
Different portfolio managers have different preferences for how their packages are structured. Depending on performance, the accelerator can easily be the most lucrative component of the package: but it is not guaranteed.
Hedge funds will often try to tilt the balance towards the accelerator to offset the danger that a new hire secures a huge cash guarantee and then underperforms or coasts.
“Someone can just come along and suck [at trading] and walk away with investors’ money,” said an executive at a top family office. “It’s a philosophical misalignment.”
The most talented people can command cash advances in the tens of millions of dollars, payable either up front or in the case of the largest payments, spread over a few years. These cover everything from deferred pay and earnings foregone at their old employer, to compensation for the time it takes to hit full earnings potential at their new fund — and for the career risk of moving at all.
Accelerators instead offer portfolio managers a greater than usual cut of the profits — 30 or 40 per cent, for example, rather than 20 per cent — on an agreed amount of gains for the fund. So a portfolio manager might be able to negotiate themselves an extra 7.5 per cent share of the trading profits on the first $1bn as in our example, or even more.
Some sceptics think the talent war will inevitably cool and pay will fall, as hedge funds increasingly struggle to pump out returns high enough to justify the payments.
But even if the multi-manager boom fades, there may still be others willing to pay. Trading firms such as Jane Street and Citadel Securities or family offices such as Michael Platt’s BlueCrest may simply step in to snap up the best talent.
“Do you think [Real Madrid striker Kylian] Mbappé will be paid less next year? It’s not happening,” one industry executive said. “[Pay] will keep increasing every year; it’s just the market.”