What Crisis? Fund Management Bonuses Approach 2007 Peak

Asset managers can look forward to a bump in bonuses and base salaries this year based largely on performance, according to consulting firm Greenwich Associates.

Based on a survey of more than 1,000 financial professionals, the firm projected a 5% to 10% increase in incentive compensation and a 3% to 5% raise in base salary for 2014. These estimates would put buy-side bonuses just 6% below 2007’s peak.

Furthermore, the report said equity managers are expected to out-earn their fixed income counterparts, thanks to the bull market and strong investment performance.

The firm calculated senior equity managers at an investment firm or mutual fund would make about $570,000 for 2014, compared to their fixed income manager peers’ $350,000. These figures are also slightly higher than last year’s, which remained at $530,000 and $340,000 respectively.

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“These ongoing positive trends are making asset management more appealing as a career choice for financial professionals, relative to a sell side that is still plagued by reduced compensation on results, intense regulation, and somewhat diminished social status,” the firm said.

greenwich compensation

Greenwich Associates said bonuses at investment and commercial banks were far from reaching the pre-crisis high, as they still lagged behind by more than 40%.

“The buy side looks particularly welcoming relative to a banking industry that still has not recovered fully from the global financial crisis,” the firms said. “By nearly every metric, the sell side is not what it once was as an employer.”

However, it’s not all good news for the buy side.

While hedge funds pay their managers almost twice as much as traditional asset managers, their incentive compensation trails the pre-crisis peak by 35%, the firm said. Managers’ bonuses are also likely to flatten this year, largely due to disappointing performance, with both increases and decreases ranging from -5% to 5%.

“At the very least, [strong performing hedge funds] will be able to maintain incentive compensation at current levels,” the firm said. “Meanwhile, increasingly selective investors will continue to spurn funds that fail to deliver performance, and employees of these funds will see compensation continue to stagnate and even decline.”

A larger allocation to hedge funds could reduce risk and increase the Sharpe ratio, but the current fee structure “feeds mediocre strategies,” according to MPI.

The California Public Employees’ Retirement System (CalPERS) recently dumped its $4 billion hedge fund portfolio citing difficulties in scaling, but one research firm said there are significant benefits to holding a larger allocation—if the price is right.

“One of our prime considerations in reviewing the program is whether we believe we could scale the program to a much more significant part of the overall portfolio,” said Ted Eliopoulos, CIO of CalPERS, last week. “Our analysis, after very careful review, was that mainly because of the complexity of the hedge fund portfolio and the cost we weren’t comfortable scaling the program to a much great size than it currently held.”

The Absolute Return Strategy program made up approximately 1.3% of the pension’s total assets of almost $300 billion.

Research firm Markov Processes International (MPI) used a hypothetical pension portfolio based on CalPERS’ policy benchmark as of July 1, 2011 to calculate risk and return with varying levels of hedge fund allocation.

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Using fund of hedge funds with assets over $1 billion—and tested for both 3-year and 7-year periods—it found a 1% allocation barely moved the needle in the portfolio profile.

“Depending on the investor focus, a 1% or no allocation might make more sense if one is only looking at the recent return profile,” MPI said. “Otherwise, for a longer time horizon or under other measures mentioned above, a 5% or 10% allocation to hedge funds makes more sense.”

According to the firm’s calculations, adding a 10% allocation to the portfolio reduced its risk and upped the Sharpe ratio over the most recent 3-year period. Over the 7-year period, the allocation helped significantly lower volatility and increased the portfolio’s annualized return.

A 5% allocation to hedge funds also offered a consistently higher Sharpe ratio than a portfolio with no absolute return program over both 3-year and 7-year periods.

However, MPI argued CalPERS’ exit from hedge funds highlights the industry’s fee structure that “feeds so many mediocre strategies and allows the universe of managers to grow.” The pension plan stated it had paid $60.7 million in management fees and $55 million in performance fees for the 12 months ending June 2013.

“While selection at such an insignificant allocation does not have the ability to impact the total portfolio’s risk-return profile, CalPERS’ experience underscores how difficult it is to select superior funds,” the firm said.

Instead, hedge funds should be incentivized only for attaining specific performance and risk goals, the firm said, beyond capturing beta.