With a sentiment finally beginning to recover in 2010, the number of new fund launches began to increase. Some 420 new funds launched in 2006 with collective assets of $37 billion in what proved to be the peak of the market. In 2010, this number was at 157, compared to 142 in 2009.
As the financial crisis developed in 2007 and 2008, many of the recently launched funds, particularly those that set up in 2005 and 2006, succumbed to market conditions and disappeared. This stemmed from a combination of net redemptions from the industry and negative fund performance. Outflows by investors were fuelled by dissatisfaction with performance or by the need to cover redemptions, particularly with funds of hedge funds, from their own client base.
In the years prior to the credit crunch, ample liquidity and an appetite to embrace risk meant that seeding an alternative investment vehicle was comparatively straightforward. However, as the crisis took hold, many funds closed down due to poor investment strategy, minimal controls, or simply bad management. This led to a consolidation in the industry. High-profile managers left the industry and decided to remain out of the immediate market until sentiment changed and improved. Some of these formulated plans to launch again either in association with other managers in their network or as a bolt-on to larger institutions.
The market has also witnessed another change. As some hedge fund boutiques have struggled to raise assets, they have looked to team up with other similar firms to help grow their business. Thus in 2010 M&A activity increased as firms looked to partner with other firms so that they could secure a larger distribution platform. Man Group’s acquisition of rival hedge fund manager GLG Partners is a prime example of this. Man Group needed more investment content, GLG needed a bigger distribution footprint. The industry has also seen smaller outfits being purchased by their larger equivalents.
What have the changing fortunes of the industry meant for talent in the market? In 2008 and 2009 we saw a large number of money managers and analysts looking for new opportunities. We also saw a significant number of other candidateswho had developed a variety of skill sets associated with setting up a business and managing the day-to-day operations. As the number of new fund launches gathered pace during 2010 and into this year, hedge fund managers have inevitably had the pick of the talent in the market. The increase in the number of hedge funds setting up in London has seen some investment banking staff jumping ship mainly due to the pressure banks are under to constrain, defer and restructure bonuses and pay only a small proportion of that in cash.
At a senior level, most hedge funds have been successful in recruiting staff: they have the advantage that performance and contribution to the bottom line is more transparent and bonuses can therefore be higher than in investment banks. This can be a powerful incentive to lure the best bank prop traders to alternative investment firms. But traders have also come to realise that a hedge fund firm can be hit by diminishing levels of capital as the redemption rates can sometimes increase due to factors outside of a portfolio manager’s control. Hedge fund managers, for their part, have learned to be more creative in recruiting and retaining these individuals. In some cases, the hedge fund firm has to be more willing to share information with the manager about the underlying product and the client or clients. Even though a recent survey specifically highlighted how traders now realise that a majority of their bonus will be deferred and not paid in cash, there are still attractions to being part of a hedge fund firm. One is that hedge funds can provide portfolio managers with the platform to implement alpha-based strategies which in the right market environment can lead to a higher remuneration package.
The role of the quantitative analyst has also grown in importance. Such individuals typically come from investment banks and have significant experience in developing complex statistical and pricing models from the middle or front office. Hedge funds provide quants with a more commercial environment where they may be able to contribute on multiple levels to the wider performance of the company. One recent recruitment search has shown that the need for highly advanced technical architects and algorithmic developers has enhanced the remuneration packages on offer to them.
Operations and infrastructure staff have typically come from larger asset managers or the investment banks. As the hedge fund industry’s growth went into reverse, large numbers of these individuals returned to their former roles with institutions. There are still a considerable number of these candidates on the market looking for opportunities with alternative funds. Infrastructure at a newly set up fund is absolutely critical, especially in how it applies to information technology. Since hedge funds judge it imperative to recruit top talent in this area of the business, they are often prepared to pay a premium for the right skills.
In light of recent activity in this market, the regulatory spotlight on the industry has significantly intensified during the past three years. With more funds being launched in the UCITS III format plus a number of market reforms and directives proposed in the US and throughout Europe, this has forced hedge funds to increasingly focus on their risk management procedures and systems. This has obviously led to an increase in demand for risk and compliance staff and therefore the salaries on offer. Recent searches in this area have seen an increasing number of these types coming from the investment banking industry.
Attracting high-profile senior professionals also shows the regulatory bodies that the hedge funds are taking the governance area very seriously. Before 2008, the reputation of hedge funds was quite heavily weighted towards its performance. Now risk management policies and personnel are considered just as important when hedge funds go to investors to raise capital.
Despite the carnage of the past few years, the hedge fund industry has startedto grow again. As more hedge funds enter the market, there will naturally be increased competition for talented individuals, both among alternative investment firms, the wider asset management industry and investment banks. In particular, the continued regulatory focus on hedge fund managers and their need to provide greater transparency and disclosure will carry on driving up remuneration packages for risk, compliance and IT staff.
How to remunerate analysts and traders will continue to be challenging. It is likely that the attractions of getting equity in the business will become much more powerful. The industry has realised that it needs to be more innovative and creative in how staff are recruited and retained. This is likely to involve continued evolution in how remuneration packages combine base salaries, cash bonuses, deferral provisions and claw back terms. For hedge fund managers to keep the talent they have happy, imaginative remuneration terms will be critical.
Prash Arora is the Head of Asset Management at specialist financial markets search and selection agency, Allemby Hunt.