Help us determine a fair compensation structure and non-competes for a new HFSubscribe
Your feedback will be critical in determining some key points our build out of a HF. I'll be showing this to the largest owner of the GP.
1. What is the lead PM (design, trade, manage, research, and market) portion of a 20% performance fee for a high return/high vol but with a very attractive sharpe ratio HF? I’ve seen numbers such as half (50% of the total performance fee, or 10% of the excess performance for a 2&20).
2. What is the typical length of a non-compete is such a scenario, and what pay should be provided during the non-compete period?
I currently am a portfolio manager at a small asset manager (about $1B, but growing fast). We manage a few equity mutual funds (average about 4.5 stars). It’s a quant/fundamental mix and there are a few PMs named on each fund (I am one of them, owner/CIO another, and one more PM). We also do some basic asset allocation strategies for some clients (I primarily built the AA process). I’m paid base + bonus I have no problems with my firm and I’m currently quite happy.
I’ve been here 3+ years, but I have 13 years total in some form of a PM role in asset management. Part of my background pre-joining this firm is in building/designing/trading quantitative tactical strategies. In this case it was all in long only ETFs, so it wasn’t a hedge fund. Last year we had a client that had a need for such a strategy so I built something for him that fit his long only parameters.
I saw an entrepreneurial opportunity, so I greatly expanded on that and built a potential HF (primarily using futures) to pitch to the owner/CIO. At a high level think various interconnected/independent risk on/off signals tied to factors, technicals, economics, some additional quant techniques etc. Arguably 100% of the design and coding was solely done by myself (technically I bounced a couple ideas around, so you can round it down to 99%). I pitched the idea last year, got good interest, but nothing imminent. After all it was just a great backtest, so it is reasonable to be skeptical. I’ve been running it live on ‘paper’ this year, and it is up around 80% YTD (this is not my long-term expectation). Regardless a month or two ago the decision was made to launch. All the paperwork/legal/ops are getting finalized. We are expecting somewhere in the $30-$50m range to start with. It will be 2% and 20%.
My role will be to design/code the entire strategy (already done), manage it daily, continue to research, trade it daily (if needed), and create any marketing materials for it. A couple of the other lead PMs (owner/CIO, plus another key PM) will be passively involved, think firm level oversight. If I got hit by the bus it would generally still run automatically (as it is quant), but they would lose maybe 20% of the things that only I could do. If I got hit by a bus and something in the code broke it would be really hard for them to fix it (but possible). I’m certainly going to train them up on it, but that key man risk will always exist to some degree.
First let me say I’m happy here, and I think both of us (myself and the owner/CIO) wants us to have a long-term happy business relationship. So, it is a matter of coming up with something that is fair and market-like. We are just new to the HF world.
1. So, the first part of the negotiation has to do with compensation. Remember I’m already being paid base + bonus for running the mutual funds. My research has shown lead hedge fund PMs in this type of role generally get about 50% of the performance fee (or 10% of the overall excess performance in the case of a 2&20). In my opinion, that is near market rate PLUS the HF doesn’t have to pay me a base (since I already get it). I recognize my research in this case could be wrong (hence why I’m posting here!).
The owner/CIO is coming from a lower tracking error/less key man world of mutual funds where bonuses are a bit more discretionary but tied to performance. Either way, that seemed very high to him. His other point is I am already ‘working’ for the company (although nothing in my current role had anything to do with designing, managing, trading, marketing a HF), but the reality is it is already built. Plus he is providing the ops, paid for the legal and all set up, and has the connections for initial capital. All fair points.
So in my opinion I should sign a contract for 50% of the performance fee (no additional base, even though it is more work) to manage the strategy. If I needed to hire any help, their bonus would come out of my 50%. The worst case scenario would be my additional bonus up to his discretion. Another important note is I will be part of the GP (about 5 to 10%). While that is good and I’m thankful for that, I’m obviously looking at the total package.
In this very unique scenario, what type of performance-based compensation is fair (forget the units in the GP, I can scale things down to make it equivalent)? What would the ‘market’ rate be if someone was recruited to manage such a HF?
2. Next what about non-competes? I fully expect that I’ll be expected to sign one, especially as part of the GP. I have no problems with this, provided the comp is fair. Worst case scenario would be an awful comp package plus a long non-compete, but as I said before I do think we want to come up with something fair and market like. What is the typical length of a non-compete? During the non-compete period does the firm typically pay the (former) employee? If so, how much? Is there any relationship between the length of the non-compete and the compensation package?
I do plan on showing him the replies to this thread as I do think we want something fair, but we are handicapped with our newcomer knowledge of the HF world. So your responses can be quite critical in us coming to a fair agreement.