Working at a Small Hedge Fund Can Make You Rich – or Put You Under

Making it to the hallowed position of partner, or member, at a small hedge fund can be extremely lucrative. But with more such funds going under, portfolio managers are seeking the sanctuary of a larger firm.

In the last two months of 2012 a cadre of small firms went out of business as more investors chose to put their money with larger firms and the cost of running a hedge fund rose.  In the US, Grant Capital Partners, and Weintraub Capital Management, both of which had around $1bn in AUM, shut down in the final two months of 2012. In the UK, meanwhile Edoma Partners, Ridley Park Capital, OMG Capital and Apson Capital closed and returned funds to investors. In the first half of 2012, more than 400 hedge funds closed their doors, according to Hedge Fund Research.

Most smaller hedge funds operate a limited liability partnership model which in boom years is extremely rewarding for partners. At Capula Investment Management 21 people shared a profit of £138.6m last year, and its founder Yan Huo, received £56.6m, while Brevan Howard spent £74m on its 49 partners in 2012. Even when performance isn’t great, compensation can be – profits at Sloane Robinson nearly halved last year, but 17 partners still shared £34m.

To meet the costs of running a hedge fund these days, most need at least $250 million in assets under management, according to research from Citi Prime Finance.  And when a small fund goes under, it’s the partners who bear the brunt of the losses.

“If a hedge fund goes into the red, the partners are liable for the loss up to the value of their stake,” said Tim Wright, head of compensation for asset management at  PwC. “Partners are also not classified as staff, so they have no employment rights if the company closes.”

For example, the high profile London-based firm, James Caird Asset Management, set up by Moore Capital Management trader Tim Leslie nine years’ ago, closed its $1.6bn credit fund in 2011, but only filed its latest accounts at Companies House in late December 2012. It lost £5m for the period to April 2012, and this came out of the eight partners’ £22.8m initial investment.

Portfolio managers are now seeking the safety of an ‘institutionally-sized’ hedge fund, according to Anthony Keizner, managing director of US hedge fund headhunters Glocap.

“Managers are increasingly looking for stability,” he said. “Bigger size also gives protection because assets generate fee income to cover the basic operating costs of the firm. Even if performance is weak, there’s a much greater chance of the firm’s long term survival.”

Larger firms also pay their portfolio managers more. Glocap’s figures suggest that the average compensation at a hedge fund with more than $4bn in assets under management  (AUM) was $5m in 2012, versus $1.1m at funds with less than $500m AUM.

“While ‘critical mass’ was once $100m or $200m in assets under management, funds below $1bn are still feeling the pressure of being sub-scale,” said Keizner.