Hedge fund aspirants set to return to banks

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By:
Helen Avery
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Launches find it hard to raise capital; Investment banking salaries prove more appealing

Hedge fund launches have overtaken liquidations for the first time since 2008. According to HFR, 585 funds were liquidated as of the end of the third quarter this year compared with 715 launched. In 2008 and 2009, more than 1,000 funds were liquidated each year, while launches averaged around 700 a year.

With the role of proprietary trading remaining uncertain, traders have been leaving investment banks to set up shop on their own. For example, three new high-profile hedge funds have been created by former employees of Goldman Sachs’s principal strategies and alternatives investment group over the past 12 months. Eric Mandelblatt, Pierre-Henri Flamand and Mark Carhart have all begun their own funds. Andrew Hall, a Citigroup energy trader, launched Astenbeck Capital in February.

But several factors point to reasons for wannabe managers to stay put.

A senior manager at a global prime brokerage firm in New York says that the capital-raising environment remains challenged. Although launches have overtaken liquidations, the number of hedge fund launches is still on a par with those of 2008 and 2009. "The flash crash of last May caused a moment of circumspection within the bullish environment and slowed interest in new hedge funds," he says. "It’s not that investor appetite is not there, it’s just that it takes longer to raise capital."

Ray Nolte, managing director at SkyBridge Capital, which runs a fund of funds and seeding business, agrees that attracting seed capital is difficult. "There is not a lot of locked-up capital out there right now, and some managers are finding that frustrating," he says.

Nolte says that pedigree remains crucial in attracting investors. "Investors want to take comfort in the background of a manager and how he or she performed during the crisis," he says. Performance, however, while having been steady this year, has not been hugely impressive. As of the middle of December, the average hedge fund returned 7.1% over 2010 – streets ahead of minus 19% for 2008 but a disappointment over 2009’s 20% returns. The second quarter of 2010 brought down the year’s returns after the flash crash and bailout of Greece caused market turmoil.

Hedge fund launches still low but beat liquidations

Number of launches versus liquidations

Source: HFR


One head of prime brokerage says investors can be happy with a 7% to 10% return but it won’t be enough to earn hedge fund managers a performance fee. "That’s tough for small firms that might not have earned performance fees for three years now," he says. As a result, he adds, hedge funds need to be large to withstand a decrease in performance fees. "If you have $5 billion in assets, the management fee alone is enough to sustain a business."

Ken Heinz, president of HFR, says that inflows over 2010 were still focused firmly on the $5 billion-plus managers. In the first two quarters of 2010 all positive net inflows were seen only for this larger-sized hedge fund. In the third quarter, $14.2 billion of the $19 billion in new capital went to large managers.

Nolte says traders who were considering leaving banks’ prop desks are recognizing the difficulties of managing a business and the cost involved. "People thought they could raise $200 million out of the door, but really they can only get about $25 million to $50 million. That’s not enough to run their strategy," he says. As a result, some start-ups are having to turn to private equity firms for investments, or consider locked-up fund structures or closed-end structures in order to raise capital.

Given the difficult environment, some market participants are predicting that in 2011 hedge fund employees will be seeking to leave the industry and return to sales and trading desks at investment banks.

"The economy is showing signs of improvement but we don’t expect a full recovery for several years. Many employees are therefore looking for a stable job with a higher basic salary"

Nicholas Wells, Carrington Fox

Nicholas Wells, director at Carrington Fox, a boutique headhunter specializing in front-office banking placements, says that compensation changes in Europe mean that hedge funds will struggle to compete with the salaries being offered by investment banks. Regulation in Europe now requires that investment banks tether salaries to their long-term profitability. In the UK, bonuses are linked to a percentage of salary, and if bonuses exceed a predetermined threshold, at least 70% has to be paid in share options or longer-term vehicles. With commissions now forced to decrease, Wells says investment banks in the UK have doubled basic salaries overnight in some cases. "Within sales and trading, managing directors used to be paid around $150,000 in the UK around three years ago. Now we are seeing salaries of more like $350,000, with a vice-president role collecting around $150,000 to $250,000 compared with $120,000 three years ago."

Wells says that back at the peak of the financial crisis those wanting to leave hedge funds were looking to join other funds. "On the back of large redemptions across the AI [alternative investments] market, we are seeing them want to leave to rejoin an investment bank. The economy is showing signs of improvement but we don’t expect a full recovery for several years. Many employees are therefore looking for a stable job with a higher basic salary."