Top hedge fund manager made $3.7B last year. Does this give anyone pause?

Great Debates
1

Yes, $3.7 billion , as in 3,700 million dollars. That’s more than the GDP of 58 countries according to this list. Countries like Greenland, Belize, and Aruba. Does this concern anyone else? To me, it’s not just the number that is startling, it’s issues that surround hedge funds and the effect such things may have on the economy. Things such as:

  1. There is little transparency. These funds take pension funds and invest them in risky trades with little to no oversight. Individuals who indirectly invest in these funds have no idea where their money is going, or how it is being used.

  2. There is no incentive to properly weigh risk. When you make risky trades with someone else’s money, you either get a huge payday (see above) or you apologize and get a new job elsewhere. They share in the good times, but not in the bad. For every George Soros, there seems to be an Amaranth that goes belly up, and leaves the investors out to dry. In fact, the guy at Amaranth that lost almost $6B himself started his own fund, and is currently advising another fund.

  3. The compensation they receive is unearned. Many charge annual fees equal to 2 percent of their assets under management, and take a 20 percent cut of any profits. Despite this, they collectively do not perform much better than their competitors.

  1. While it’s up for debate, they seem to engage in shady practices and have a deleterious effect on the markets. A few cites on this:

A. Hedge funds could be behind late stock swings

B. Jim Cramer explains on TV how to manipulate the markets

C. “As if that wasn’t enough, the tremors came at a time when hedge funds were under increasing scrutiny by politicians and regulators concerned about their growing impact on global financial markets. With total assets of more than $1.8 trillion, the industry has nearly doubled in size since 2004, and the activities of hedge funds can increasingly move markets. The danger posed by these lightly regulated vehicles, which employ strategies such as short-selling, trading in derivative securities, and leverage, to the financial system has been demonstrated before — most vividly by the 1998 implosion of Long-Term Capital Management (LTCM), a giant American hedge fund that lost $4.4 billion in six weeks and had to be bailed out with the help of the U.S. Federal Reserve to avert a market panic.”

D. ["Soros, the founder of Quantum Endowment Fund, one of the world’s largest hedge funds, was dubbed “The Man who broke the Bank of England” for his role in betting heavily that the pound would fall in 1992. As a result, Britain suffered a humiliating exit from Europe’s exchange rate mechanism – the precursor to Europe’s 12-nation currency. It was rumored that Soros earned $1 billion in a day with his bet against the British pound.

Though analysts say Soros’ influence in markets has waned, many agree with the gist of his remarks and are reluctant to fight a trend that has pushed the dollar down sharply against major currencies. Soros was sharply critical of Snow’s policy shift, branding it a “mistake” and labeling it a wrongheaded attempt to stimulate the U.S. economy at the expense of other economies."](http://www.globalpolicy.org/socecon/crisis/2003/0520soros.htm)

Isn’t all of this something we should all be really really concerned by?

2

Why? If someone freely agrees to enter into a financial arrangement that ends up with someone making this type of money, what concern is that of anyone? Merely because you envy them or see them as not “earning” their income (which is patently false – they earned it as much as anyone earns his or her income), why is that a reason to be concerned about this?

Why should a large amount of income be any more startling than someone making, say, $50,000 or $100,000? Unless someone obtained this money by force or fraud, it’s not really any of your business.

3

Righto renob, these guys earn every penny. Of course when they lose money for the fund,it should not be a mark against them. Hell they get well earned raises.

4

Winfall Tax! It makes much more sense to tax this guy than the oil companies.
I belive there is very good evidence of collusion in these hedge funds-they also can influence exchange rates, by planting rumors.
other than that, the huge profits are proof that markets are NOT highly efficient-they do not do a good job of accurately reflecting intrinsic value.

5

Yes, they earn their money. How? They do work that someone pays them for, just like everyone else. Their skills and their luck has enabled them to find jobs that people pay them very high salaries for, sure, but the principle is the same as anyone who earns a salary.

If you don’t think they earn it then please tell me the standards you use to determine what one’s labor is worth. I say a person’s labor is worth whatever he or she can negotiate with someone else to earn. You obviously feel there is some objective determination that says that labor is only worth X but not Y. Please tell me how you have such grand knowledge about what people should be paid.

How so? What is the objective measure of “intrinsic value”?

6

If people want to invest with hedge funds let them, but there should be more transparency into them, especially if otherwise-beholden retirement or mutual funds are allowed to invest in them.

Same deal with compensation. Sure, it’s not a great deal for investors but whatever floats their boat. If they somehow scheme to get compensated outside of the agreement then sure, they should be penalized.

7

How about the people who have pensions that do not have a direct say in said arrangement?

8

That’s the trade off to having a pension. That’s what you signed up for when you took a job that provided a pension as a benefit – you got the money when you retire (hopefully) but in return someone else was making the choices for you.

9

I really don’t care how much hedge fund managers make. It doesn’t make a whit of difference to me. If someone wants to invest their money in risky business where a good slice of their profits go to someone else, that’s their business, not mine.

My only concern with hedge funds is whether they can have an effect on the broader markets, such as with the Asian meltdown ten years ago. That effects people. How much a hedge fund manager makes really only effects the people who invest their money with him.

And as far as the “they earned their money” comment goes, snake oil salesmen earned their money, too. The fact that their money was earned does not confer legitimacy to the business they engage in.

10

I don’t care how much money a person makes, as long as they aren’t doing anything illegal. My problem with these guys, though, is that they get some special preference for how their income is taxed. The way I understand it, they only pay 15% by claiming their income is capital gains. Not sure how that works or why it’s justified, but seems to me that that loophole should be plugged.

11

I assume you’re using the royal you, because there are a lot of people who are forced to change their retirement plan when their company changes hands. Not to mention that, as idealistic as it would be, most people can’t pick and chose their job based solely on who’s managing their pension.

The “(hopefully)” part is why it’s mucked up that that there are limited to no repercussions to the person responsible for failure, while the workers are now left without a nest egg.

12

Let me address your list. For background, I have worked middle and back office for hedge funds; front, middle, and back office for asset managers; and I currently consult to the asset management industry, which includes hedge funds and other ‘alternative investment’ managers.

Individuals who invest in these funds must be either ‘accredited’ or ‘qualified’ investors. Hedge funds cannot market themselves at all, and must be diligent against introductions to non-qualified investors.

Some hedge funds are very opaque. Well-run pension plans avoid these. Pension plans demand transparency, and because of the investment $$ involved, often get what they want. I attended a conference where an investor for CalPERS (largest U.S. pension plan) was agonizing about how hard it was to find hedge funds who met their qualifications. She related that some funds that qualified did not want to provide CalPERS the transparency and turned down the investment.

There is plenty of incentive to properly weigh risk. The same could be said of investment banks, who, had they properly stress tested their mortgage portfolios, might have avoided some of the huge losses they suffered. Instead, they chased returns regardless of risk, all of them thinking their smarter than everyone else and have found a way to break the risk/return tradeoff.

Unearned? It is not like they are throwing darts at a board (though it may seem that way). Their compensation is as unearned as that as a mutual fund manager (which is where many hedge fund managers begin). Remember my previous point - these are unmarketed investment vehicles. If an investor wants to invest, he must search out the hedge fund and prove that she qualifies to invest. Are there shady managers in the hedge fund industry? You betcha, I’ve met a few. Doesn’t mean the industry is evil.

There is a lot of hubris amongst the managers in the industry, even the ethical ones. They are all chasing returns, and there are a number of asset managers (of which hedge fund managers are a subset) taking shortcuts. It is not unique to hedge funds. Are you aware that Cramer was a hedge fund manager? If Soros was wrong in his bet against the British pound, then his article would have read like the LTCM article. Damned if you do, damned if you don’t.

John Mace, there are many, many different compensation models for hedge fund managers. If they draw a salary, it is treated like a salary. If they draw on their personal investments in the fund they manage (and of the many dozens of managers I’ve met, all invested in their own funds), then the gains are taxed like the funds gains, which means that realized gains on any security held more than 6 months are passed through the fund to the investor and treated as a long-term capital gain. Short term capital gains are treated as income. Again, executives having tax consultants lessening their tax burdens is far from unique to the hedge fund industry, and is more directly related to the loopholes written into the tax code.

13

I agree with your comments, that’s why I think pensions are a ridiculous way of funding retirement. They are bad for both workers and companies. Pensions are a remnant of a bygone era that are pretty meaningless to people of my generation (twenties and thirties).

14

John was of the opinion that this loophole should be closed. (As am I.) After all, they don’t own the funds themselves.

15

Exactly. I mostly mentioned the top salaries because making that much money generally entails taking great risks that investors might not take if presented with the relevant info. Often, it also mean taking actions in a way that end up manipulating prices in certain markets.

16

I’d agree with this. I think if X % of your income is from capital gains, it should be considered your “primary source of income” and taxed via the income tax brackets that we have.

People shouldn’t be able to make an enormous amount of income through a certain means and then not have to pay into the income tax system.

I understand why the capital gains tax rate went down–it’s good for people to invest. I’m a conservative, and I generally believe in as little taxation as possible. However, I also firmly believe in the graduated income tax brackets, I probably disagree with many people here as to what the top marginal rate should be–but I don’t feel that you should be able to get out of paying that rate when you’re in a situation where you can just make sure that all of your take-home pay is coming in the form of capital gains.

It’s getting a bid ridiculous when we have Fortune 500 CEOs taking small salaries so they can earn most of their money through capital gains and thus avoid paying the top marginal rate.

As for hedge funds, they were never intended to be places where mutual fund managers put people’s retirement money. Individuals can only invest in hedge funs when they have satisfied certain net worth/income requirements for a reason–the government doesn’t really care if rich people speculate wildly with money they don’t need to feed their families, but they don’t want ordinary Americans getting fleeced because they don’t understand the market.

I primarily blame mutual fund managers and other managers of retirement funds for this development, they decided to start investing in hedge funds because they were getting good returns there–but it is questionable if these managers should have the authority to subject people’s retirement money to such risks without their consent.

To me, the problem really isn’t hedge funds, it’s people who manage money for thousands of individuals deciding to invest in them that gives me pause.

17

John didn’t say what loophole, or offer anything more than hearsay. One of the funds I worked at handled the incentive fees (which was the only money our manager took from the fund, which meant he didn’t get ‘paid’ when he was down) as a transfer of fund assets from limited partners to the general partner (the fund manager). When the limited partner withdrew money from the fund, it was a withdrawal from the fund, hence it was taxed based on the realized gains and investment income earned by the fund - a mix of ordinary income (dividends and interest), short-term capital gains (securities liquidated within 6 months of purchase), and long-term capital gains (securities liquidated held for at least 6 months). Any hedge fund manager worthy the title will try to maximize the last category when it is time to liquidate, as it is in his and his clients’ best interests. The other manager of the hedge fund (not the general partner, but also required by his terms of employment to be an investor in the fund) was paid a salary and a bonus based on performance, but this was all treated as ordinary income.

If you think the capital gains tax is a loophole, well, I can’t help you there, but I’ll fight eliminating that. I’m no billion or even million dollar fund manager, and I don’t want nor need Uncle Same taking an extra 20%+ of my stock gains.

18

The only reason why hedge funds purportedly influence the markets is because three is a lot of a lack of, or rather, a lot of imperfect information out there. It’s one thing to fraudulently say something about a market or purposely put out misinformation and act to benefit from it, the SEC takes care of that will well-defined rules. It’s quite another thing to claim that this influence is somehow “wrong” or an indicator of a broken system. In the LTCM wiki article, it states that LTCM’s bets were eventually correct. LTCM faced the same problem any individual investor would have faced just on a much, much larger scale.

The difference is that these hedge funds have skin in the game, i.e. the money from the fund. It is up to the individual investor to trust whether or not to use a particular hedge fund/HF manager. There’s plenty of other investment vehicles out there, e.g. ETFs, mutual funds, stocks, bonds, etc. The SEC will easily come down on someone posting misinformation on a message board, but will be hard pressed to come after a hedge fund influencing a market with its own money, i.e. the exact way information is supposed to be sent through the market place, via money, buying/selling share, placing contracts, options, etc. Besides, no fund is big enough to totally dominate the market, and investors are too skittish/distrustful to uniformly follow a HF into a loss.

To regulate any of this will mean that we as a society will have to regulate greed. I don’t see that happening ever. I wouldn’t mind seeing some transparency, but that runs the risk of exposing any trade secrets or other proprietary information gives one hedge fund a market advantage over the rest. The attorneys in my finance division will vehemently oppose any such regulation. I’m not saying any regulation is impossible, just that it has to be measured, and I’m not totally convinved that what we have now is inadequate.

19

Here’s the way I understand it, and correct me if I’m wrong (which I could very well be). The top hedge fund managers all (or almost all) take the compensation as payment out of the fund as capital gains from the fund. They call it “two and twenty”-- They get paid regular salary on 2% of the fund and then “carried interest” of 20% of the return of the fund. That latter income is treated as capital gains. But I don’t see the difference between that and regular income except which column you write it under on a spreadsheet.

When someone is compensated with stock (or stock options), they have to hold that stock for the prescribed time to get special tax treatment, and that entails some risk.

20

Has this changed recently? I ask because a former neighbor of mine was a hedge fund manager who was prosecuted by the SEC a few years ago, and I had the impression that he was just a regular joe who sold his investment concept to institutions (and lost pretty much all of it, including millions of dollars from the Art Institute of Chicago).