At senior levels most hedge funds have been successful in recruiting their quota of analysts in the first half of 2006 and there seems to be no sign of this picture changing as the year progresses. For senior analysts the hedge fund 'sell' argument is a strong one: performance and contribution to the bottom line are more demonstrable and bonuses can consequently be significantly higher than in investment banks.
For the 'foot soldiers' of research, the link between their work and the success or failure of a fund is a less clear one and their share of the reward pie consequently much smaller. Base salaries tend to be roughly equal to those on offer in investment banking, and bonuses only a little higher. However, without direct financial incentives, the attractions of the hedge fund sector for junior analysts quickly pall. Investment banks tend to mean a 'name' on a still relatively empty CV and they also usually mean the sort of structured career progression that is still only the province of the very largest hedge funds.
A partial solution lies in greater creativity in both recruitment methodology and the structuring of compensation packages. Larger funds are working to build a recruitment 'brand' through campus based campaigns and through strategic press leaks to highlight the rewards on offer to top earners. Funds of all sizes are implementing schemes which maximise the value of bonuses, such as those where employees at even the most junior level can use their earnings to invest in the fund without administration fees, but with the added incentive of a top-up contribution from the firm.
The quantitative analyst is a relative newcomer to the hedge fund arena but is rapidly becoming the 'must have' accessory for any serious player. Quantitative analysts develop and employ mathematical formulae to price derivative products, work with traders to develop trading and hedging strategies through statistical analysis tools, and analyse past trends to predict future market movements. The roles call for people with highly developed mathematical ability, preferably with front or middle office experience in derivative pricing or complex statistical analysis. Recruiting and retaining these individuals has been proving to be a difficult business for even the largest and most prestigious funds. The problem lies in an almost fundamental mismatch between the world view of the classic QA – conservative, thoughtful and risk averse – and that of fund managers, who have built their fortunes by pushing the boundaries of asset management. The prospect of large bonuses alone is not the solution. Many QAs are also motivated by an environment where they can indulge their academic interests with time, space, the company of like-minded people, and access to cutting edge technology. On this particular battlefield, few hedge funds are likely to win out against an investment bank.
Our expectation for the remaining months of 2006 and into 2007 is that more hedge funds will learn the lesson that successful recruitment of quantitative analysts will stem from ignoring the crowd and focusing on a select few – namely those individuals who want to break away from a purely technical role into a multi-faceted one where they can contribute directly to the commercial performance of the business. Here, hedge funds will be able to play to their natural strengths.
The competition to attract and retain the best proprietary traders has occupied most recruiters throughout the first half of 2006 and will doubtless still be doing so when the year is just a distant memory. Theoretically, hedge funds should have a natural advantage over their investment bank opponents. Traders are risk positive by nature and the flexibility that a hedge fund can offer them to adopt more aggressive strategies can lead to higher returns and higher personal reward.
Despite the attractions of substantially larger bonuses, proprietary traders are becoming increasingly aware of the potential pitfalls of moving to a hedge fund. Traders are also aware of the difficulty of building long-term business in set-ups where the levels of capital can rise and fall with alarming rapidity. At the same time, investment banks have been coming up with imaginative new strategies to hang on to their best people. In an over-crowded marketplace, recruiters need to convince their targets that theirs is a long-term proposition, something which means duplicating on a micro scale many of the elements that investment banks perfected long ago. It may be stretching the comparison a little but, in the eyes of many potential recruits there are increasing similarities between today's hedge funds and the companies that made up the great dotcom boom of the late 1990s. The bursting of that particular bubble taught us all that sustainable success doesn't necessarily attach to those with the best ideas or the best product but rather with the best commercial management.
Recruitment is just part of the puzzle that will keep hedge fund managers busy over the coming months. The other key piece is how to hang on to that star trader once you actually have them. Locking people in using such crude methods as direct contractual restrictions is a risky strategy. Again creativity is rearing its head in 2006. One of the industry's leading players has allegedly given its senior traders an almost cavalier freedom to leave and either join a competitor or set up their own funds, but with the caveat that their former employer will retain the right to invest up to 50% of the capital in these strategies.
So far in 2006, the need for qualified staff to develop and run infrastructure has largely been met through defections from the investment banks. Experienced product controllers have been tempted to make the move across by the prospect of working closely with the front office and by the lure of larger bonuses. In recent months the flow has also been accelerated by the overall shortage of such individuals across the whole asset management industry. The consequence of this shortage has been a willingness on the part of banks to accept staff back if their move to a hedge funds doesn't work out. The risk element of moving that deterred so many infrastructure specialists in the past has therefore largely been eradicated.
It seems that in 2006 the increasing maturity of the hedge fund sector has begun to be mirrored in the way that firms approach the thorny human resource challenges of recruitment and retention. Managers have come to see that, in order to keep up the flow of talent into key areas of operation, and to source that talent ahead of rivals both within the sector and from the investment banks, they will need to approach HR matters in a more imaginative way than ever before. The simple employment of healthy basic salaries and substantial bonuses is unlikely to provide the sole solution to these issues across the rest of 2006 and into 2007.