Over the years we have been asked by many hedge fund candidates to help them understand the compensation structure of Private Equity and Hedge Fund investment roles. Although some hedge fund candidates believe the compensation is identical this is inexact. Private Equity and Hedge Fund firms may pay the salaries of their investment professionals in a similar way, but the performance based bonuses are a main component of total compensation for both firms and they are calculated very differently.

Hedge Fund Compensation Overview

Hedge Funds are selected by investors and compensated by investors based on the fund’s yearly return. Therefore, performance driven compensation for these funds is based purely on yearly return numbers and the fee’s generated from those returns. 

If the Hedge Fund’s compensation was not based purely on yearly return numbers the interest of the fund’s employees would not be aligned with the interest of the fund’s investors.  Hedge Fund employees are therefore paid based on their performance and the performance of the Hedge Fund for the present year. 

In many cases the yearly performance driven bonus is paid out over a 2-4 year time period.  The employee knows their bonus figure and this figure is locked in but the payments are spread out over time instead of being paid in one lump sum. This concept of stretching the full payment out over years is fairly new to the industry.   

Private Equity Fund Compensation

Most Private Equity funds’ yearly performance numbers are based on hypothetical return on investment and the fund’s true ROI can not be determined until a capital event occurs (such as the selling of one of their investments).

In order to keep the employees’ interest congruent with that of the firm’s investor the payout structure works differently than at a Hedge Fund.  Employees at Private Equity firms are paid a yearly performance driven bonus, which comes from the firm’s general fee structure. In most cases this bonus is smaller than it would be at a Hedge Fund which is compensated on the fund’s actual ROI each year. 

Once a capital event has happened a second performance driven bonus may also be awarded to the employees. This bonus is commonly referred to as a “Carry.” Not all employees may receive a percentage of the carry but the carry pay outs have generally been moving lower down the Private Equity fund’s hierarchy each year for the last few years. 

Five years ago very few funds would reward their Senior Associates with a percentage of the carry. Now many firms offer carry when hiring Senior Associates to remain competitive in the marketplace.  In many cases a percentage of the carry bonus must be kept in the fund before being taken out, usually 2-4 years.

Weighing the Details

Both types of investment organizations pay very well when their performance is strong, but it is important for you to understand the differences in how the pay outs are calculated.  Many organizations are now a blend of Hedge Fund strategies and Private Equity strategies which makes the compensation structure even more complex.

While, we would never suggest you choose one type of investment organization over another based purely on how the compensation is calculated, we want you to be educated about the payment structures and their differences.