In recent weeks, there have been a number of articles lamenting how much hedge fund managers get paid.
“Most Hedge-Fund Managers Are Overpaid, Big Investor Says”
“Everyone Knows Hedge Funds Are A Rip-off”
“Hedge Fund Moguls Pay Has The 1% Looking Up”
Most of the assertions are, once again, predicated on the assumption that hedge funds all look alike. After all, if Forbes runs an article highlighting the top 25 hedge fund earners and a manager that raked in $280 million in 2013 takes the number 24 spot, all hedge fund managers must be making serious bank, right?
Most of these articles point to two sources of hedge fund manager income: the management fee and the incentive allocation. It seems that the management fee causes the most ire for investors and pundits. This flat fee is charged on the assets under management, or AUM, of the fund. If a fund manages $2 billion for investors and has a 2% management fee, the manager makes $40 million in base salary. Right? Well, maybe.
But let’s think about this logically.
- There are only about 500 funds (out of 10,000 or more funds) that manage more than $1 billion;
- The average management fee is actually closer to 1.5% than 2%.(around 1.64% by my last calculation);
- So yes, there are some hedge fund managers that can earn millions without investing a penny.
Hedge funds getting rich off their management fee are the exception, not the rule.
According to Hedge Fund Research, 56% of hedge funds managed less than $10 million at the end of 2013. That’s right, I said roughly 5,600 hedge funds have ten large or less under management. Those managers’ management fee payout? $200,000. And that’s if they are a solo operation. If they have to pay additional traders, administrative or back office staff, that number only decreases.
Another roughly 21% of funds managed less than $100 million according to HFR. Their total team base pay? $2 million bucks assuming a (not average) management fee of 2%. If you have a team of even five professionals, that’s $400,000 per person. More labor-intensive strategies split the money amongst more people.
Sure that’s more than a kindergarten teachers makes, but it’s not out of the realm of normalcy in business. Even small business owners with ten years of experience earn more than $105,000 while small business owners in New York can top $125,000 per annum according to Chron. In comparison, kindergarten teachers earn between $39,000 and $77,000.
And that’s just small business owners. Most CEO’s of Fortune 500 companies make up to $1 million in base salary per year. In 2010, the median bonus for Fortune 500 CEOs was $2.15 million. And in case you think that the bonus equates to an incentive or “pay for performance” fee in hedge funds, research in 2011 showed 97% of companies paid bonuses. Bonuses in corporate America have become pretty much ubiquitous.
I get that hedge funds have become in many ways the poster children for economic inequality, and I do think that perhaps it’s time to think of a sliding management fee scale based on AUM. However, I find it difficult to tar all hedge funds managers with the same "fat cat" brush.
As for the incentive fee, since managers only receive this if the fund performs, I have heard less pushback on that front. I guess it’s hard to argue with making money for, well, making money.