Hedge funds are taking punitive measures to rein in bonus payments, tying pay to longer-term performance and behaviour.
SAC Capital Advisor’s move to clawback bonus payments from portfolio managers and analysts who fall foul of securities laws is still a rarity. However, with the Alternative Investment Fund Managers Directive (AIFMD) pushing for deferrals of up to 60%, hedge funds are increasingly making it clear that a bonus award is no longer a guarantee of payment.
“Regulators are demanding deferrals at hedge funds and while clawbacks are unlikely, malus arrangements – where payments are dependent on performance criteria over a number of years – are increasingly common,” said a prominent asset management compensation consultant in London who declined to be named.
European regulators are demanding that 40-60% of bonuses are deferred over three years, but even in the U.S, where a hands off approach to pay has been maintained, it’s typical to defer 50% of compensation over $300k for two years, suggests Anthony Keizner, managing director of Glocap, which produces an annual compensation report on hedge funds.
“A more punitive deferral scheme not only measures longevity but also ties to performance – if performance is poor in periods after a banner year, then the deferred payment can be reduced or even eliminated,” he said. “This has proved simpler to implement than a standard claw-back – it’s easier to hold back unpaid compensation than to take back money after it’s been paid out, and oftentimes, spent.”
A tougher approach to compensation among hedge funds will be music to the ears of the big banks, which are losing staff. Deutsche Bank’s chief financial officer, Stefan Krause, recently lamented how bulge bracket banks are losing talent to hedge funds that are able to pay out higher bonuses. BlueCrest Capital Management, for instance, has just hired an entire team from Nomura’s principal investments team - Ardy Hashemi, Alex Codrington, Russell Hartley, Basile Rivoire, Sam Joab und Dan Cohen – following the appointment of Christian Dalban, who headed the division, in March.
Deferrals are not the only method hedge funds are using to rein in their compensation. Keizner said that firms are often asking for deferred compensation to be re-invested in their funds. This is still comparatively rare – just 30% of those surveyed for the 2013 Hedge Fund Compensation Report said that they were required to reinvest bonuses in their funds.
All of this is driven not by a desire to appease regulators, but to placate investors who are asking for limits to be put on risk-taking. Hedge funds are increasingly chasing institutional investors like pension fund and endowments, which demand steadier returns and certain limits on compensation, said Keizner.
“The counterbalancing force to this ‘risk management through compensation’ is the increasingly competitive market for talent,” he added. “A sudden introduction of such measures forced by an investor could be met with the reaction of star analysts leaving for new platforms where they’re not subject to these conditions.”