What I've Learned About Hedge Fund Structure and Compensation
Hedge Fund Structure
Over the last few months I've realized just how diverse hedge funds are, and how little people (both in/out of the industry) understand about the different structures. This is my attempt to distill some of the bigger differences in 'team structure and compensation'. It's a detailed answer to a question I asked two years ago: .Tiger cubs vs. hedge fund gaints. This isn't really about investing strategy (credit vs. l/s equity vs. activist), though certain strategies lend themselves better to certain structures. Hopefully others can chime in with additional insights.
Hedge Fund Terminology
To begin, some terminology:
Hedge Fund Manager (Manager) – Has ultimate control over the fund. Often the entrepreneur that started the fund, and usually starts out as the portfolio manager as well.
Portfolio Manager (PM) – Makes go/no –go decisions on what gets into a portfolio and how its sized.
Sector Head – In charge of a specific sector within a fund (e.g. technology sector head, health-care sector head). At multi-manager funds sector heads are often also portfolio managers, though sometimes they are just analysts with seniority
Analyst – can have different seniority/ titles, but this is essentially anyone that researches ideas and sells/pitches them to a Portfolio manager, who ultimately gives the go/no – go
Different Fund Structures and Compensation
Single Manager Funds
Most common type of fund. Consists of one PM and any number of Sector Heads/ Analysts.
Pros: adaptable to a wide number of investing strategies; often a good mentoring environment with a high degree of access to the senior decision maker(s); generally the fastest structure in terms of decision making; less bureaucratic/ more transparent; analysts will often be involved in decision making, etc
Cons: The size of an investment team under this structure is pretty limited. Once the team reaches a certain size (10+ analysts) some of the advantages will start to fade and it will become more hierarchical
Pay: Varies a lot, but generally good transparency. Fairly typical for a manager to end up with 50% of total profits one way or another
Often what happens when a single manager fund grows up/ gets too big for one person to make all the investment decisions. The fund is then split up under multiple PMs/ sector heads that have discretion over their own portfolios and 'sector teams.' Exact implementation can vary widely, from a system where individual PMs have broad discretion over investing decisions (a la a multi-manager platform), to one where the manager/ chief investment officer is still heavily involved on each team.
Pros: Effectively same as single manager, less access to manager level senior people but preserves access to portfolio decision maker (PM)
Cons: By definition, sector team structure means these are unlikely to be generalist roles.
Pay: Roughly comparable to single manager funds. For analysts, may be slightly less on the margin since your P/L will be split with both your PM and the manager
Multi-manager platforms seed PMs who run independent funds. Each PM is tasked with implementing a specific strategy and the 'platform' then takes some cut of the fees. Four of the better known American examples are Citadel, SAC, Millenium, and Balyasny. Platforms tend to make extensive use of leverage, and have correspondingly strict risk limits (e.g. limiting volatility and total drawdown). The best PMs are rewarded with more capital, while underperformers are terminated. As a result these can be very high pressure places to work, though not necessarily directly competitive (PMs will generally have limited concern/awareness of what/how other PMs or the fund in aggregate are doing, as it doesn't affect their own PnL).
Pros: PMs and analysts can just focus on investing, since administrative details are often taken care of by the platform. Can also be incredible lucrative, though this depends on the details
Cons: Can be incredibly high pressure. PMs that don't perform are frequently fired (along with their analysts). Constraints on risk taking can also encourage short-term thinking
Pay: Depends on the platforms deal with the PM, and the PMs deal with the analyst. Deals can range from ~10 – 20% of total PnL (i.e. very high relative to pay elsewhere). Platforms can afford this because of leverage. For illustrative purposes:
Assume the platform/GP's average performance fee is 22%. Take a billion dollars, leverage it four times, split it among eight teams ($500M each). The average team returns $50M (10% is decent in risk-constrained/beta neutral style) and the average team takes $8M (16% * $50M). Total compensation to the teams is $64M (8*8) and the GP makes $24M (22% - 16% = 6% *$50M = $3M * 8 teams). Net returns to the LPs will then be $400 - 66 - 24 = $312, or 31.2%.
Hedge Fund Examples
SAC: Technically a family office now. Styles vary widely, from short-term/ trading focused (holding periods of a few weeks) to longer-term, fundamental, or even deep value teams. Team size varies, with some small (2 – 4 people teams) and some teams that are like mini idea factories (i.e. analysts crush on analysis and don't even know what's being put in the portfolio)
Citadel: Nearly everyone here works within a market-neutral (0 net exposure, $s long = $s short), relative value framework (though some of the carveouts, e.g. Surveyor, are different). At the extreme end, some teams/ analysts cover a well defined universe (30 – 100 stocks per analyst), and are expected to be invested in most of them at any given time. These teams tend to trade in pairs (long company X, short company B in same sector to hedge out sector risk).
Citadel is known for having very strict risk constraints (re: max allowable drawdown, market exposure, etc) and if you consistently break them you will be out of the job in very short order. Opinions vary more than I'd expect on whether this is a good place to work. The biggest complaint I hear (my people are long term value guys) is about the obsession with the short term (e.g. trading quarters)
Balyasny/ Millenium: Roughly similar to SAC/Citadel. Balyasny tends to be a bit more varied in terms of style, while Millenium (like Citadel) is more strict on the short-term/relative-value trading
Notes on Hedge Fund Manager Compensation
Under any structure, the two things that drive pay are basically AUM/ person and seniority/ shared economics. Consider that an analyst at a $5 - $10B fund will sometimes make single investments that are $200 - $500M, bigger than many small funds. An analyst (senior) that gets a share of the economics can thus easily make more than the manager of a successful smaller fund.
Comments, questions, and additions welcome. I'm sure I've completely missed some interesting things. Does anyone know what Blackstone's proposed 'big-bet' structure is all about?
Edit: edited discussion of platform economics per conversation with PEHFVC below
Looking to Break into the Hedge Fund World?
Want to land at an elite hedge fund use our HF Interview Prep Course which includes 814 questions across 165 hedge funds. The WSO Hedge Fund Interview Prep Course has everything you'll ever need to land the most coveted jobs on the buyside.