Managers face staff defections as bonuses look shaky
Mediocre performance this year has left only one in every 10 hedge funds above its high water mark, a portfolio’s previous net high which it must breach to be allowed to take 20% of profits from existing investors, financing bonuses to retain staff.
About 90% of funds are below their previous highs, according to a snapshot of 4,000 funds for Financial News taken by database Eurekahedge on July 31. Only 2.8% of funds of hedge funds and 10% of equity long/short portfolios have reached their previous best, while 14% of hedge funds focusing on market events and 15% of those investing in distressed debt have done so. Hedge funds on average lost
-3.29% this year to July 31, as well as a 1.32% fall in August, leaving many under water.
Tom Brown, European head of KPMG’s investment management practice, said the industry’s fixed management fee, normally 1% or 2%, would cover business costs, but in normal circumstances bonuses would be covered by the incentive fee. The industry has trumpeted performance fees as aligning its interests with those of investors.
Brown said: “You would not build your business on needing the performance fee to survive, but if you weren’t earning it in the long term staff would get fed up and look for something else.”
David Billings, partner at lawyers Akin Gump, said managers needed to ask: “Can I retain staff during this period and how long will it take to get back to the high water mark?”
David Butler, partner at London business consultant Kinetic Partners, said funds had been starting to calculate performance fees without using a high water mark, charging it annually. He said: “If a manager who thought he would raise $1bn for a fund raises $100m, but hires people on the basis of raising $1bn, the management fee might not cover all the costs. In an ideal world the management fee at least covers all the operating costs of the business including basic salaries.”
Managers whose funds are trading below their high water mark can ask their investors to consider resetting the mark, although investors may be reluctant if this means being charged twice on the same performance. Billings said some managers might use other approaches, such as asking investors to pay a reduced incentive fee until the fund has exceeded its high water mark by a certain amount.
As some funds have taken in billions of dollars with industry expansion, the fixed management fee could be large in absolute terms, so incentive fees may not be as important to retain staff. However, managers of smaller funds usually rely more on incentive fees to compensate staff and pay overhead expenses.
The problem for hedge funds does not look like easing soon. Nicola Meaden, chief executive at London-listed alternatives company Alpha Strategic, predicted some hedge fund managers would not be able to charge performance fees on their existing assets until early 2010, although they could do so on new money, which is not subject to the pre-existing high water mark.
Meaden said for several months investors had been asking how many funds could cover operational expenses just with their management fee. Meaden said that hedge funds’ staff should not expect performance-related bonuses if performance did not justify it.
She said managers needing cash could consider trade sales, mergers or doing a deal with her firm by swapping an agreed portion of the income from their fees for Alpha Strategic shares. She said: “There’s a more receptive audience out there now for this kind of option.”
One manager said firms not earning a performance fee could also shut funds and then re-emerge with new ones, which would start without previous highs to reach.
He added that so many funds were below their historical highs that staff who were not paid a performance fee at the end of this year might not have much option but to stay put.
del.icio.us
Digg
Newsvine
reddit
StumbleUpon
