Guest Blog: The Future of "2-and-20" in Hedge Fund Manager Salaries

Best Hedge Funds Co. discuss the future of Hedge Fund Manager Salaries.

The money being bandied about in the top echelons of the hedge fund industry draws a lot of ink from the media these days – and not just on the business pages. For the cohorts of hedge fund managers busying themselves out of the spotlight, it does serve as a bit of light entertainment. And of course, you’d be foolish to deny a strong streak of envy towards those needing a small security van to deliver their salary. After all, envy can add an extra dash of motivation to the hedge fund manager’s game.

But away from the top 10 ten-digit salary numbers, what does the future hold for hedge fund managers – new starts and old hacks alike? Most hedge fund managers salary brackets can be parcelled out in multiples of $100k. More prosaic numbers maybe, than Paulson’s ‘stuff of legends’, but still impressive, especially if the performance is there to generate the returns.
So of course, the mainstay of hedge fund managers salary-guessing in the industry revolves around performance-casting. With the base model of ’2-and-20′ fee structures having held in place for the last decade or so, the lion’s share of hedge fund manager compensation has generally come from the pile they can earn for their investors.

That leaves hedge fund managers looking to market trends in their sector – and their ability to match or beat them – to provide a benchmark for forthcoming salary expectations. But the bigger picture lies with the fee structure itself. Will investors continue to pay 2% management fees, and a 20% performance cut ad infinitum. Especially when returns in the industry remain substantially on a level with stock market returns?
The first thing to realize is that concerns over performance-fee levels neglect the fundamental point from an investor’s perspective. They only pay out to the hedge fund managers salary when the returns are there. 20 percent of nothing is nothing – so investors are in a no-win no-pay situation, which is gives them a level of reassurance. So the perennial worries of big pay-outs to managers, in good years, are overblown – the investor is winning big too.

The second thing is that investors get in on hedge funds in order to have the opportunity to make returns that exceed the usual – and whilst the ‘average’ return across the alternative investment sector may look disappointing at times, a sizable chunk do out-perform benchmarks. It is the desire to be one of those, that jumped onto the right ship, that motivates many accredited investors to move their money hedge-wards. As long as that potential is there, they’ll remain happy to see hedge fund managers incentivized by a strong participation rate.
Still, there are moves by some funds towards performance fees that are based on benchmarks-adjusted rates of return – or even on actual realized gains, as opposed to mark-to-market nominal values. Liquidity was a big bug-bear of the last crisis, and the disparity between potential monetary gains, and real-world one, glaringly apparent. That will inevitably affect hedge fund managers salary levels.

But these measures will only succeed in drawing a critical mass of investors to those funds where revamped fee-structures don’t hit bottom-line performance. With the big players shouting their success from the parapets, and able to ramp up performance-fee levels on the back of those results, the marketing appeal of lower fee-cuts may be lost. Investors may read low performance fee rates as marking a lack of appetite. So the likelihood is that 2-and-20 will stick around as a big part of hedge fund manager pay – for as long as hedge funds are the ultimate ‘status-symbol’ investment vehicle.

This article was contributed by Best Hedge Funds Co.  Let us know what you think!

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