Compensation Change in Private Equity and Hedge Funds?

In the past six to seven months, the bulge bracket investments banks here in the United States have had to deal with new regulations, increasing pressure from Washington DC, and a fairly negative public opinion.  One area in particular has been under much scrutiny from both the public and Washington DC - compensation.  As these two demographics have demanded changes to the compensation, these investment banks have had to make changes to their pay structures to stay competitive and retain their top talent. In many cases this meant doing away with high percentage performance based bonuses and trying to make up for this compensation in salary.

The effect of increasing the employees’ base salaries, in some cases by 100+%, has had varied results throughout the industry.  UBS was the first to raise their MD’s salaries to around $400k. Since then you have seen almost every other firm agree to similar raises.  These raises have occurred not only at the MD level but through many levels of the organizations.  Though the year end bonuses have been reduced to appease the general public and Washington DC, the increase in base salaries allows these professionals to remain highly compensated compared to the general public.

The Effects of new base salaries in Private Equity and Hedge Fund firms

An important question for those presently employed in the alternative investment space and those interested in joining the alternative investment space is; how will these raises affect the Alternative Investment industry especially Private Equity and Hedge fund firms?  In the past, many of these firms have used the base salaries at bulge bracket investment banks as the guidelines when creating compensation structure within their firms. It is unrealistic and cost prohibitive for most funds except the very largest to raise their bases salaries anywhere close to the new ranges at the bulge bracket firms.  The .5-2% management fee that most funds charge their investors can not cover all of the firm’s general operating cost in addition to large increases in base salaries.  Their inability to compete with these new salaries under the current generally accepted fee structures is cause for concern.

This worry is even more accelerated since many firms are coming off an 18 month period where they are still below their HighWater mark and thus have not earned performance fees.  It is these performance fees which can help cover additional costs that management fees do not meet. Without these performance fees, some firms are running in the red before even trying to make their compensation more competitive.

Will the best on Wall Street still want to migrate over to the Private Equity and Hedge Fund side or will they stay on Wall Street in order to receive a larger guaranteed check? This new compensation structure will certainly keep some risk averse professionals working as investment bankers. However, I believe the ultimate goal for most professionals in this industry will still be to make the move over to the buyside.  Hedge Fund and Private Equity firms will not be able to guarantee larger checks but they will be able to truly reward for performance.  It is the aspiration of being rewarded for one’s achievements and being able to increase the compensation exponentially beyond the base check that will continue to drive the best and brightest into the buyside world.

As long as Private Equity and Hedge Fund firms must keep their management fees within the currently accepted range, which is most likely the case, these funds will become even more performance oriented. Now their employees will not be the richest people on Wall Street unless their fund performs. And in a world where one’s income is very important and viewed with great admiration, it will be imperative to the employees to see to it that their fund performs extremely well.

I am sure we will see the larger funds increase their salaries at some point which could make them become more attractive to many professionals.  But the professionals must look at the overall opportunity and the ability to move up and be promoted internally at these large funds.  Many professionals join the Alternative Investment space with the goal of becoming a partner at their fund. This is less likely to happen at the larger funds hence those looking to make the move into this industry will have to take this key issue into consideration when choosing an employment opportunity.

One final point; would not making these Private Equity and Hedge Fund firms more performance oriented be good for not only the employees but more importantly the investors?  When everyone’s interests are aligned investors are much happier and the funds have a greater chance of success.  Although funds will start to hear cries from Alternative Industry professionals and those interested in joining the space to increase their base salaries, I do not think it is the wisest option and in most cases would probably not be accepted by the investors.  Perhaps the comparatively lower salaries but greater upside potential is just what the Alternative Investment space needs to create new and greater wealth and opportunities for all involved.
© 2008 NyamiNyami Holdings, LLC