Hedge Fund Industry Trends: 2010 and Beyond

Post-crisis rebound boosts industry recruitment

Heidrick & Struggles

The following excerpted notes and observations are from a recent report on employment trends in the hedge fund industry by leading advisory firm Heidrick & Struggles.

Search/recruiting activity
Q4: Significant increase in hedge fund hiring across all functional roles, especially portfolio management and marketing/distribution. Talent inventory for senior Long/Short Equity talent decreases significantly, we estimate over 80% of Long/Short Equity PM and Global Macro talent and marketing/distribution professionals re-absorbed and in good/stable employment situations; around 50% available Event-Driven senior talent re-absorbed into similar such situations.

Q4 and 2010: Post-TARP bank brain-drain reversal of fortune. Continued significant increase in hiring at most large banks/proprietary trading firms; hedge fund talent also being absorbed by asset management firms, family offices, pensions, endowments, foundations, incubation/seeding platforms, sovereign wealth funds (ex: C.I.C and S.A.F.E.) and most recently the SEC. We expect compensation bidding wars to return in 2010 though not at the levels prior to Summer/Fall 2008.

Long/Short Equity talent being absorbed throughout the industry, from the largest firms (SAC, Millennium, Citadel, etc.) to proprietary trading banks, asset management firms, sovereign wealth funds and seeding/incubation platforms. Global Macro talent being absorbed by large macro firms (Brevan Howard, Moore Capital, etc) and by estimated 65 new Macro fund launches in 2009.

Emergence/re-emergence of seeding funds Blackstone Alternative Asset Management and Morgan Stanley’s newly launched incubation vehicle in Q4 and numerous other incubation funds. Also, significant lift in funding of emerging managers by legends of the industry: Tiger Management/Julian Robertson, Soros/George Soros, SAC/Steven Cohen, Millennium/ Israel Englander, Blackstone, Man Group, Citadel/PioneerPath Capital. Seeding platforms and incubation platforms actively set for 2010 deals.

Top tier, new fund launches in Equities, Macro, Commodities, from best pedigreed players: Tudor, Raptor, Moore SAC, Pequot alumni, etc. Only ‘A’ players getting funded, ‘B’ players no longer getting funded. Shift however from 2008 multi-billion dollar launches to 2009 hundred million dollar launches. We expect to see recently launched funds reach the billion dollar mark more regularly in 2010, though not with the frequency of 2008 launches and as a result of performance combined with raises.

Well-known existing high profile hedge funds launching new funds: AQR, Brevan Howard, Paulson & Co, Marathon Asset Management, Citadel, Harbinger, Kellner Dileo, Ospraie, Tontine Partners, Raptor Capital, Noble Partners, Caxton.

New business roles
Throughout the year we have also seen continued activity in classic Business Development/Strategic Planning roles. These BD roles continually evolving as the industry evolves. In BD roles, candidate typically spending portion of time on core internal operations, from marketing to operations and personnel, and majority of time on new business development – from seeding deals, to strategic fund raising, and associated new structures (ex: UCITS, Long Only funds, SMAs, global initiatives, etc) to tap into new assets and allocations. Such BD roles are sometimes held by the current or incoming firm or divisional COO.

Marketing/distribution hiring has been extremely active throughout the year – with continued need for experienced sales and marketing professionals – as firms hoping to capture sidelined assets, new assets (ex: retail) and assets from poorer performing funds.
Firms are gearing up for the “best fundraising opportunity in two years.” Demand for marketers with corporate and public plan track records is very high.

Q4 hiring included: Kane Anderson, Highbridge, OchZiff, Atlantic, Jana, Lanexa, DE Shaw, Bridgewater, AQR, Fir Tree, Citadel, Millennium, Blackstone (BAAM), Carlson Capital, Marshall Wace, MSD Capital, New Mountain Capital, Renaissance, Marathon, Blue Mountain, Stonewater Capital.

HR, hiring expected
By Q2 2009 the number of dedicated HR/recruiting personnel within hedge funds had contracted significantly; many hedge funds laid off all but their most senior HR/recruiter personnel; in some cases, valued HR/recruiting personnel shifted into other roles (special projects, investor relations); several of the largest and most sophisticated in-house recruiting teams within the hedge fund community were downsized by 40+%; by Q3 2009 downsizing had stopped, but most hedge funds had no plans to grow their HR/recruiting teams through the remainder of 2009. Bank and hedge fund human resources and recruiting hiring picked up slightly from what has been an essentially contracting market for much of the year. More hiring expected in 2010 for these functional roles.

Client interest in Investor Relations picked up in Q4 as well after several quarters of slow hiring activity, especially when compared to marketing/distribution.

More mandates for movement and upgrades in COO, CFO, and COO roles. Fund of hedge funds situation has improved in Q4 after very tough year, though core fund of fund value propositions in need of fundamental re-evaluation. Little activity in fund of fund hiring, with a few exceptions among the largest fund of funds. Globally we are seeing consolidation and emergence of ‘Top 5’ fund of funds that are actively hiring and growing.

Front office compensation activity
In 2009, compensation bands for senior level portfolio management and marketing/distribution roles were broken and depended on whether fund was underwater or not, and whether underwater fund had modified high-water mark or not. Formulaic payout structures for PMs remain strong and expected to continue to remain strong in 2010 as various platforms compete for and retain senior investment talent.

Return of guarantees expected in 2010, although increase in clawbacks and deferrals also expected.
Also, factors other than compensation continue to influence individuals for all roles as stability of hedge fund capital base, management expertise/reputation and alignment between allocators/investors and both GPs and employees assumes greater significance.

Compensation: sales/marketing

How compensation packages are structured:

Base salary: The majority of sales & marketing professionals who accepted offers in 2009 did so within a base salary range of $150,000 – $250,000. On average base salaries have held steady from 2008 levels, though many individuals experienced an increase or decrease, depending on the type of firm they were transitioning to.

Guaranteed bonuses: A small percentage of mid to senior level candidates secured a significant guaranteed bonus. Seven figure guarantees for 2009 were reserved for the top 5 – 10% of senior level talent, with multi-year guarantees secured in just a handful of situations. Typically these seven figure guarantees were offered to highly regarded heads of distribution or individual contributors who had discernable and successful multi-year track records of raising assets even in difficult markets, and who joined firms at the front of the pack from a performance and pedigree standpoint. These seven figure bonus guarantees ranged from $1 million to $3 million per year.

Minimum bonus floors: These were secured in 20 – 30% of job moves. Typically, candidates regard these floors as an insurance policy and gesture of strong intent, but these offers do not make them ‘whole’ from their previous compensation levels. Any potential upside beyond the minimum floor will be discretionary. Minimum floors ranged from $200,000 – $600,000.

Discretionary bonus: The majority of sales & marketing talent (60%) accepted offers of base salaries plus a purely discretionary bonus. Expectations for these discretionary bonuses are all over the map, and largely reflective of uncertainty around Q4 fundraising and fund performance for the remainder of the year.

Commission bonus: In 10 – 15% of situations, a formulaic/commission structure will be the sole determinant or a component of an individual’s end of year bonus. The debate continues about whether these commission structures result in better fundraising performance and whether they are being implemented to a greater or lesser degree – we were not able to determine market consensus on this issue.

Equity: It remains extremely rare for candidates to be offered equity walking in the door, with the exception of senior individuals entering into highly entrepreneurial situations. A small percentage of sales and marketing professionals expect discussions around equity to be on the table after one or two years with the firm.

Compensation: portfolio managers

Structuring of Compensation Packages:

Base salary: The majority of PMs who accepted offers in 2009 did so within a base salary range of $150,000 – $300,000. On average base salaries have held steady from 2008 levels.

Payout salary: The majority of PMs who accepted offers in 2009 did so with a payout formula of 12%-20% of the P&L, with a large number of funds paying at the 15% mark.

These relatively high payouts have remained in tact/have not changed since 2007-2008 when many of these ranges were originally set to attract/retain PM talent. At the larger more established firms, PMs do not assume netting risk, and therefore can earn a payout even if other teams perform poorly.

Allocations: Range from $50 million – $500 million, mostly in the range of $75 million – $350 million.
Expense allocations: Most funds allocate expenses to PMs. Expenses can include cost of capital, compensation for team members, and variable costs associated with running a PM’s P&L. Overhead/seat charges are rare.

Guaranteed bonuses: A very small percentage of senior level candidates secured a significant guaranteed bonus.

Minimum bonus floors: A very small percentageof senior level candidates secured a significant guaranteed bonus.

Discretionary bonus: PMs at established funds in excess of $10 billion sometimes participate in profit sharing pools.

Equity: It remains extremely rare for candidates to be offered equity walking in the door at large and/or established funds.

Hedge fund talent flow 2010
With significantly increased competition for top hedge fund talent in Q4 2009 and an active hiring market expected in Q1 2010, especially at hedge funds, proprietary bank desks, and hedge fund incubation/seeding platforms, we expect to see a clear talent flow trend where hedge funds with certain characteristics will lose their senior most talent and where others will retain their investment professional talent.

Based on a Q4 2009 survey of Long/Short Equity PMs in the industry, we have divided firms into two categories.

I. Firms where talent is stable
The following characteristics are shared by firms from where it is difficult to pull talent:
1) Strong individual performance (and strong firm performance when manager netting risk exists)
2) Fair/well-run management, good and transparent work environment and interests well aligned between GPs, LPs and employees
3) P&Ls/books not heavily restricted; relative autonomy
4) Access to sizeable capital that is stable
5) Lucrative/competitive payout models

Succession planning and location in some instances is also a key factor. Some PMs aspire to eventually run a firm so succession planning may be a factor. Location can also be a factor. California (SF, LA) and Boston locations, for instance, are geographies where it is sometimes difficult to relocate talent. Though it should be noted that 2009 saw a significant number of candidates making geographic moves for the right opportunity given that opportunities were few and far between.

In most cases it is very difficult to pull out a strong performer especially when a firm provides most/all five pros listed above. One PM said he would be “shocked” if anyone from his firm raised their hand for another opportunity because they have all the pros discussed above. A PM at another firm but in a similar situation said everyone seems “glued to their seat” and very happy. A sector PM at this same fund said “I am never leaving as long as they have me.” At yet another firm with stable capital (significant portion is GP money), a PM would not consider a move unless the opportunity had $1 billion of capital with good economics and a good work environment.

So what would it take to pull a strong performer from such a situation that meets most/all of the criteria he/she find important? In a case where most/all pros are offered, a ‘game changing’ opportunity would be needed. Examples of game changers: very significant increase in capital allocation or responsibility upgrade to more distinguished top-tier institution/firm with many/most of the factors listed above; opportunity to build firm as well as invest, and/or opportunity to be key part of a firm’s succession plan; opportunity to serve a cause while investing: major endowments, sovereign wealth funds, and the SEC have made key hires in 2009 where candidates were attracted to the cause/mission associated with the institution as well as the investment opportunity; significant/sufficient capital to start own fund or significant allocation on a well managed platform with competitive and transparent economics.

II. Firms where talent is vulnerable
Clearly, these firms would lack some or all of the five characteristics of firms from where talent is stable. However, in surveying PM candidates we identified the following eight key characteristics of firms where talent is not locked in.

1) Firm underperformance: Clearly a main driver of talent flow: However there are two types of underperformance. PMs underperformance and/or firm underperformance but where the PM has performed well. The easiest targets are firms that have not reached their high-water mark. We have found that loyalty to a firm lasts about two years (two consecutive years of little/no bonus with uncertainty regarding year three bonus) unless one is a senior member of the firm where significant personal wealth accumulation has already occurred. In 2010, many funds will have reached this two year mark.
2) Firms without formulaic payouts for PMs: Situations where there was no formula but more of a handshake deal or subjective payout.
3) Firms where portfolios are shared: While not eager to leave, most candidates who share a portfolio are open to discussions.
4) Traditionally centralized structures: A structure where PMs don’t run specific books but instead contribute their sleeve to a multi-strategy fund or to a Senior PM/Founder/CIO. People here may be inclined to look for portfolio autonomy elsewhere.
5) Firms with dramatic top-down changes to structures: Firms where triggerpulling responsibility was yanked from individual PMs and former PMs were asked to work as Analysts contributing ideas.
6) Placeholders: Firms which are somewhat outside the norm for hedge fund PM talent but who have housed successful PMs from firms that shut down.
7) Firms under $1 billion: Exceptions are the more recent 2009 start-ups with sizeable AUM.
8) Hedge funds undergoing significant internal ‘event driven’ structural change: Mergers and acquisitions within the hedge fund industry will, unless handled well, create instability for individual P&L performers and lack of clarity. Lack of clarity/vision or lack of communication from the top down during such extraordinary internal events/times makes top talent especially vulnerable: employees become unsure of what economics will look like; some concerns around stability of capital and management.