Tuesday, May 6, 2014

Fun With Numbers: Matt Levine on Hedge Fund Pay

We posted the Institutional Investor's Alpha piece earlier this morning:
The Top 25 Highest Earning Hedge Fund Managers

From Bloomberg:
Billionaire Hedge Funders Made Money the Old-Fashioned Way
So Institutional Investor's Alpha put out its 2013 hedge fund compensation ranking today, and I guess we should talk about it because rich people got paid money and that is fun to gawp at. The obvious thing to say about this is that these managers' pay doesn't reflect performance, so everyone said it. DealBook:
They earned that hefty sum in a year when most hedge fund managers fell short of the market’s returns. ... Some hedge fund titans took home large sums of money even as their investors were left with little to show, in large part because of the sheer size of the assets under management and the fees they charge.
And you can probably guess Gawker's reaction.
Now, you can quibble that the pay of the best-paid hedge fund managers should be more or less uncorrelated to the performance of the average hedge fund: You pay the good managers not to be average. And in fact the top manager on the list, David Tepper, returned 42 percent last year. But that's only a partial defense; Ray Dalio is number 10 on the list despite making investors somewhere between negative 3.9 and positive 5.25 percent last year, versus around 32 percent for the S&P 500.1
But here is an important sentence from Alpha:
Those with sizable fortunes -- even people who are no longer managing money on a day-to-day basis -- can qualify for the ranking based simply on gains on their own capital invested in their own funds.
The thing is, this is not a ranking of payment for performance. This is -- partially? primarily? -- a ranking of return on capital. If you have money, and you put it in your hedge fund, and your hedge fund has a positive return, you will make money. If you start with a ton of money, and/or your hedge fund has really good returns, you will make a lot of money. Notions of fair compensation for your labor, or appropriate pay for performance, just don't enter into it. Money begets money, lots of money begets lots of money, and skill in the begetting is a nice bonus....MORE