Hedge funds - end of the Gilded Age?

March 29th, 2013
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Contributed by: Shane Brett, Global Perspectives
"America’s top 25 hedge fund managers make more than all the CEOs of the S&P 500 combined.” - The Economist, October 2012

Hedge Funds have had an incredible run over the last 2 decades. The annual salaries and bonuses of the most successful managers have been amongst the highest paid to anyone, anywhere, ever.

Astronomical wealth has kept everything from top end international property to luxury goods to private yachts afloat for many years. This is starting to change. Multiple headwinds of lackluster performance, increasing competition and invasive regulation are starting to bite.

This White Paper examines these trends and asks the question - have hedge funds reached the end of their "Gilded Age"?

Background

Many of the very highest earning hedge funds and private equity managers earned annual income a dozen times higher than the CEO of Goldman Sachs (e.g. Blackstone).

It is amazing that hedge fund managers have escaped the public vitriol reserved for the investment banking community. This is primarily because no hedge fund has ever been bailed out with public money and their remuneration has remained below the public radar. This is now changing, most prominently in Europe.

1. New remuneration regulation

The Alternative Investment Managers Fund Directive (AIFMD) was finalized in December 2012 and it contains some very specific rules relating to future hedge fund manager remuneration. These rules will apply from July 2013.

All hedge funds managed or marketed in the 27 European countries of the European Union will have to pay their employees at least 50% of their remuneration package in the form of shares in their funds. Cash payouts are limited to half employee’s annual income.

Furthermore, the same shares cannot be divested for at least 3 (and preferably 5) years. There is no leeway here. The rules are written in such a way that they must be directly transposed into the law of each European member state 'as is'.

The fund remuneration policy must be made known to investors in the fund. Further details will be required by their local regulator. Details of payments to staff will be out in the open and transparent for the first time. It is a sea change for the industry.

Another crucial point is that these rules apply to any fund marketed in Europe. This point has yet to be fully understood in other international locations (like the US). In future to even try to seek investor capital from Europe, your fund must be fully compliant with the wide-ranging AIFMD regulations - of which the remuneration rules are only one small part.

The Directive makes this 'third country' compliance process a gradual process but by 2018 non-European managers active in Europe will be forced to introduce compliant remuneration policies - or forsake capital investment from the world’s largest trading block.

To make matters worse the EU wants to extend their recently agreed banking bonus rules to cover hedge funds, effectively limiting annual bonuses to one time salary (or two times with 75% shareholder approval).

These regulatory changes will all have a negative impact on remuneration throughout the industry.

2. Lackluster Performance

Compounding this new proscriptive regulation is the lackluster performance of many hedge funds over the last 5 years. For this they have only themselves to blame.

Once again in 2012 many of the largest funds saw disappointing gains in a largely positive general market. Poor performance translates into far lower incentive fees and also effects potential future capital allocations.

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