Former hedge fund trader here at a big fund: these numbers are correct, but not representative. There are thousands of funds out there. Some huge and killing it, but most are small that aren't. The costs to launch and run a fund are huge, which really eats into the take home of the smaller operations. In large shops, a PM will often take half of what he earns for the manager (i.e. not for the LPs). So if he runs a book of $100m and makes 25% (so $25 pnl), the manager keeps (historically) 20% so $5, of which $2.5 might go to the PM. There are definitely guys who are making tens of millions, and obviously the guys that everyone reads about who are making much more. But the vast majority of front office personnel who are working at funds are making sub $500k/year.
Someone asked about how difficult it is to get outside investment....
It's usually very difficult and it takes a lot of money to run a proper fund.
Let's say you raise $50M. You can maybe charge 1 and 20,meaning you get 1% of assets each year for running the fund and 20% of profits.
1% of $50M( and keep in mind this is a large raise for someone without a track record on the sell side or inside another fund) give you $500,000 a year to pay:
- salaries( lets say you pay yourself $100,000 all in plus the same for a single analyst
- a Bloomberg terminal $30,000 including data feeds
- market data feeds you need $25,000/year for basic market data and fundamental data that you are allowed to warehouse(you can't store data you get from the Bloomberg terminal).
- rent $50,000/year for office space
- outside lawyer fees and outside accounting fees $100,000/year
- similar fees for someone to run your back office, roughly $100,000/year.
And on the other side of expenses you have the money making side of things. Which as the OP pointed isn't great.
If you return 10% on the 50M you get to keep 20% of that so a 10% return gives $5M in profits and you keep $1M.
That allows you to bonus out yourself and analysts on good years. If you lose money one year then you get no bonus and have to bonus out the employees out of the retained earnings you kept from previous bonuses.
it usually gets worse as most funds have what's called a high water mark. This means you don't collect the performance fee until your fund gets back to the high water mark. So if you are down 10% one year you need to make that back before you start to make any performance fee, which is why most funds shut down if they go down more than 20%.
As to raising money.....Anyone can show a model that makes money. that doesn't mean its easy to create a model, its just that there are alot of people capable of building such a model.
Its the risk management that people with money are really looking for and sadly that's just really hard to show out of a model as part of the risk management is things like positions sizing and showing your model doesn't pile into one asset class or trade correlated products.
it bodes well for the OP that they talk about market regimes as, IMHO, this is one of the biggest risk management tools that aspiring traders ignore.
And this risk management is why people ask for a track record of more than a year.
He makes a good point about paying tens in millions in fees to outside investment managers. Their fees are never worth it. I would imagine the entire investment management team could be a group of 5 people with investment experience who decide how to allocate the money into different Vanguard funds. Returns would be the same, maybe higher when you take out the 1-2% that management is taking out and putting into their own pockets.
I've said this before, but the managing director of the Norwegian Pension Fund - which currently sits at a cool $1.56 trillion, has a $657k salary. Nothing more, nothing less. The return for last year was around 25%
Some of the fund managers there make more than the managing director, but still, we're talking about a "modest" figure in the $1mm-$2mm range. That's paltry pay compared to the big bucks made in hedge funds and private equity.
The pension fund could have paid out hundreds of millions to their fund managers, and it would only have been a rounding error in the grand scheme of things...but still they manage to attract top talent.
There's this culture on Wall Street (or Connecticut, or London...) that they are the only ones that can bring big returns, because they're the right combination of correct pedigree, professional experience, network, talent, etc.
In the end, it's just good salesmanship. Tons of funds deliver mediocre returns, while making bank.
I believe what it's referring to is that traders are paid regardless of how well the funds do. Actively managed funds have fees of say 3~7% of the portfolio that are paid regardless of how well it performs and this is the bet that Warren Buffet made and won (index funds performing better than hedge funds in the long run when fees are accounted for).
The comment makes a great point about management fees:
"Well, most venture capitalists have started to optimize for management fees versus carried interest, or sharing in the profits generated. It simply makes sense to raise larger funds every two or three years so that each partner can earn $2 or $3 million a year in guaranteed fees. With exits taking longer and failures rampant, praying to generate personal returns from the carry after paying back your principle is unrealistic."
Which reminds me of a similar observation from the world of hedge funds:
"Typically, hedge-fund managers charge their clients a management fee equal to two per cent of the amount they invest, plus twenty per cent of any profits that the fund generates. (This fee structure is known as 'two and twenty.')"
"If a fund manager does well, he gets to keep a large portion of the profits he makes using his clients’ money; if he does poorly, he still receives the generous management fees, at least until his clients withdraw their money, which isn’t always easy to do."
I know a couple fund guys, and one in particular runs a really aggressive fund. His example sort of presents an exception to what you're saying, but it mostly doesn't for reasons you'll see in a moment.
I can't really discuss his strategies for producing double-digit-per-month returns, but suffice it to say, the money involved doesn't "scale". Further, it's to the fund's advantage from an institutional as well as an individual perspective to not "outgrow" their ability to maximize their returns on extant capital.
Their incentives are structured on returns and not money under management. They're also a purely private fund, it's almost entirely friends/family/registered investors that are somebody's cousin, etc.
They don't really need more money.
They just need nobody to notice how they're making their money.
Edit:
Worth noting as well that they're not part of the wall street scene nor are they based out of the greater new york area. They aren't into the marketing/sales side of running a fund, they're mostly programmer/quant/trader types that are in it for the numbers game.
They get a management fee based on the total size of the fund, not just those that have been invested. It's typically between 2 and 3% of the fund per year and in addition to 20% of the profits made, if any, from investments.
Many people were able to raise $100-400M funds during the 2003-2007 time period, and thus their management fees were $2-8m per year. That can make several people millionaires over the course of the fund life. Most of these funds did not have good returns.
I'm very doubtful that a majority of these smaller funds survive very long but really no great way of knowing. Macro funds until this year have just been sucking. Let's say you're getting 1/15 on 132mm and returned 10% (10 is generous given how a lot of these funds have performed) for the year. That's 1.32mm management fee and 1.98mm in incentive for 3.3mm total. That's really not a lot of money to go around to get startup hedge fund talent.
I'd be surprised if he got standard management fees on a fund where the "bulk" of the money comes from one contributor and they tell you how much of who to buy.
I'm not sure I would recommend investing in mutual funds in the blog post. It makes me feel cheated and sick to know that the mutual fund "managers" there (whom for the most part switch out every few years or so) get paid more for doing the same amount of "work" as the fund grows due to them taking a percentage of the fund size vs. a performance based fee.
Gotcha. I think if you take the avg fund size divided by # of partners the avg partners gets $30-40mm of a fund. So management fees alone are in the millions for showing up to work. Seems a bit high with no track record. Maybe a better model for LPs would be 1.5-2% for yrs 0-5 (when most investments are usually made) and then 0-0.5%. What do I know...
There's a lot of nuance here. A $100mm fund could be a single guy/gal working from her office, running money in an industry she knows with a little bit of admin support. In that world, $2mm a year in fees is plenty to keep the lights on. Some fund managers I know in this situation don't call all the fee; there may be social considerations / signaling the manager prefers to make. Some spend it all and then some of their own. Absolutely none of them think that the fee is 'retirement money'; they all have eyes on the prize of a 3-5x and carried interest getting them to $100m or so, when they can do whatever thing it is they want to do that got them into running the fund.
On the other hand, a $100mm fund could be a 'contender' fund that wants to raise a large fund, and is in a competitive industry -- it's trying to get on the cap tables that, say, Mayfair gets on to, and so it needs to staff recruiting support, tech help, marketing people. Perhaps it's multi-jurisdiction. In that world, $2mm is way, way too little, and the GPs may well be financing the fund personally through fund 1 and into fund 2, depending on the follow-on raise. They are aiming at running, eventually, $1bn+ per fund in three to four stacked funds, and taking home $1bn after 20 years (or less?) of good effort for each of the original GPs.
These are caricatures, and there's much more than this to the lifecycle of venture funds, but since we're at HN and VC is a big part of the conversation, I think it's good for hackers and founders to understand the counterparties they do business with, and particularly to be able to read the signals of the VCs they talk to, while the VCs are reading the signals of a desperate, out of date deck.
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