How hedge funds pay so highly: pass through fees, and their nuances
Big hedge funds are big payers. If you have the good fortune to survive at hedge fund Millennium Management in London, you will be well rewarded. Millennium's London partners received an average of £8.9m ($11.5m) each last year, while the average mere employee there was on £776k. At Millennium's archrival, Citadel, London partners were on $23m each in 2023; the rank and file got $1.5m.
These are the averages. At the upper end of the distribution, hedge fund pay numbers are even higher. There was unconfirmed talk last year of Millennium paying $50m to hire Stefan Ericsson from Citadel, albeit over a multi-year period. The 'business development' professionals who source talent for major hedge funds stand accused of offering sign-on packages as high as $120m for people they especially like.
Why do hedge funds pay so highly? Millennium founder Izzy Englander has suggested that non-competes are partly to blame: funds typically mandate that portfolio managers and other key employees must spend up to two years out of the market when they're jumping to rival employers. At any moment in time, this means some of the industry's best talent is out of action; available talent must therefore be paid more.
However, at multistrategy funds in particular, the pay dynamic is driven by more than just non-competes. Most large multistrategy funds operate a "pass-through" approach to costs, usually including compensation. These pass through arrangements mean that if a fund wants to pay a portfolio manager $120m, it can charge that amount directly to the fund's investors.
Hedge funds explain the structure of their pass-through fees in regulatory filings. Millennium states simply that, "all expenses incurred in connection with the operation of the Millennium Partners Funds, without limitation," can be passed through to investors, including pay. Some funds, however, offer a lot more detail on how their pass-throughs work.
For example, at ExodusPoint, the $13bn fund co-founded by former Millennium portfolio manager, Michael Gelband, regulatory documents state specifically that each of the following costs will be passed through to investors:
"Bonuses (including sign-on, supplemental, retention, discretionary and formulaic bonuses of any kind) paid to employees of ExodusPoint, including (a) bonuses paid to Portfolio Managers based on the gross investment performance of their respective portfolios net of any expenses allocated to such Portfolio Manager in ExodusPoint’s sole discretion (“PM Bonuses”), and (b) bonuses paid to non-Portfolio Manager personnel of ExodusPoint (other than the Principals) (together with PM Bonuses, “Employee Bonuses”); (ii) all expenses in connection with the Principals and all employees of the General Partner and ExodusPoint, including, all base compensation and benefits (including, but not limited to, healthcare contributions, premiums and claims, payroll, withholding and similar taxes, workers’ compensation contributions, 401(k) matching and profit sharing and similar retirement or savings plan contributions for employees and the Principals..."
As well as:
"Expenses relating to personnel recruiting, retention and severance arrangements of the General Partner or ExodusPoint including the hiring, on-boarding and termination of employees (such as recruitment fees and retainers paid, any internal referral payments, fees and expenses relating to participation at industry-related and professional conferences, professional organization fees, and events, expenses in connection with prospective employees’ travel to ExodusPoint’s or its affiliates’ offices, certain up-front compensation, signing bonuses, relocation expenses, buy-out and retention payments payable to employees and other incentive and compensation plans, including expenses associated with any structures employed to facilitate investment by Portfolio Managers and members of their investment teams in their own respective strategies, and legal expenses related to hiring, counseling and terminating employees)."
When investors are paying bonuses, signing-bonuses, relocation bonuses, the cost of buying out retention payments at previous employees, and travel to interviews, it's easy to see why hedge funds end up paying so well. They're not spending their own money.
Pass-throughs aren't limited to compensation. They can also cover the cost of technology, employee travel and life insurance policies, regulatory examinations, accounting and compliance, meals, and cars. At funds with offices in New York and Miami, they can pay for the cost of frequent private jets between the two. At Jain Global, the fund launched last year by ex-Millennium CIO Bobby Jain, the pass through includes, "technology and software, including platform buildout, operation, maintenance and other technology costs."
Not all funds operate a blanket pass-through model, though. ExodusPoint's documents state specifically that it will not pass through the costs of holiday parties or "purely social offsite events and entertainment." Nor will it hit investors with the cost of "office artwork" or private air travel where that exceeds the cost of commercial travel. At Eisler Capital, there's a cap on passing through "infrastructure expenses," including office rents and travel. However, all Eisler's front office expenses, including front-office related technology infrastructure are passed through and are expected to be "significant", partly by virtue of forms of "embedded incentive compensation that are not offset against the Performance Compensation."
Pass-though arrangements have their fans. One macro portfolio manager says they've enabled top funds to generate better returns for investors: "Ken Griffin has created a great business. He uses those fees to build better facilities, to create the best systems and to hire the best people, then investors benefit." In 2022, Barclays analysed 300 funds and found that funds imposing pas through expenses generated after-fee returns of 11.8% versus 6.4% for peers without pass-through billing.
However, pass-through fees also have their detractors. Earlier this year, BNP Paribas' prime brokerage team issued a report claiming that pass through fees are robbing investors of returns. At multistrategy funds with pass-throughs in place, investors only received 41c of each dollar of profit, down from 54% in 2021.
This is a problem, particularly in a world where the risk-free rate on three month treasury bills is 4.4%. Marlin Naidoo, global head of capital introduction and consulting at BNP Paribas, said in February that investors now want returns of at least 9% on their hedge fund allocations.
The implication is that funds imposing hefty pass-throughs could find investors' willingness to subsidize generous compensation heavily curtailed if they return a lot less than 9%. At Eisler Capital, returns were only 0.06% in the year to August, according to Bloomberg. At ExodusPoint, they were 6.5% through to September.
Fees are already being squeezed: ExodusPoint recently agreed not to take a cut of profits unless its returns surpass three month treasury bills. So far, though, the pass-through system is intact. This could change. If it does, underperforming hedge funds will find themselves at a huge advantage to those that can spend, spend and spend again, while investors pay for almost everything.
Eisler Capital and ExodusPoint declined to comment.
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