Monday, May 29, 2006

Top Hedge Funds Earners
Mind Boggling Numbers

You need to make US$130 million in 2005 to make the top 25 earners in hedge fund managers ranking by Institutional Investor. When it comes to pure wealth creation — arguably the biggest motivation for the majority of hedge fund managers — times have never been better. Thanks to the power of hedge fund math, driven by management fees and performance incentives, more managers are making more money today than ever before. One year ago Edward Lampert of ESL Investments made headlines when he became the first manager to earn US$1 billion in a year. This time there are two who broke the billion-dollar barrier: James Simons of Renaissance Technologies Corp. and BP Capital Management’s T. Boone Pickens. In 2005 math whiz Simons, we calculate, earned a staggering US$1.5 billion, edging out oil tycoon Pickens, who took home an equally astounding US$1.4 billion from two hedge funds he quietly launched ten years ago. Although Lampert saw his earnings cut by more than half in 2005, he still made a cool US$425 million, good enough for sixth place. Rounding out the top five are three longtime managers: Soros Fund Management’s George Soros, US$840 million; SAC Capital Advisors’ Steven Cohen, US$550 million; and Tudor Investment Corp.’s Paul Tudor Jones II, US$500 million.

This swelling of personal gains has made many hedge fund managers enormously wealthy. At least 13 of the managers out of 25 are billionaires — Simons; Pickens; Soros; Cohen; Jones; Lampert; Shaw; Bruce Kovner of Caxton Associates and David Tepper of Appaloosa Management (tied at No. 7); Israel Englander of Millennium Partners (No. 11); Kenneth Griffin of Citadel Investment Group (No. 13); James Pallotta of Tudor Investment Corp. (tied for No. 14), and Louis Bacon of Moore Capital Management (No. 19).

Investors have long insisted that hedge fund managers have a substantial percentage of their net worth tied up in their own funds to ensure that the interests of all parties are aligned. Now, as hedge fund assets have grown, and managers’ assets in their own funds have grown with them, managers no longer need to put up high returns to make a lot of money.

Six managers this year make the top 25 despite generating single-digit returns: Caxton’s Kovner, Citadel’s Griffin, ESL’s Lampert, Tudor’s Pallotta, Raymond Dalio of Bridgewater Associates and Och-Ziff Capital Management Group’s Daniel Och. Clearly, there is a disconnect between pay and performance, it appears that once you have the size, everything appears larger and stretched. People are getting paid extraordinary amounts of money for performance that is mundane and very average. As hedge funds have grown, management fees — which mostly range between 1 percent and 5 percent, depending on the manager — have become an increasingly important piece of the economic equation. Ten years ago a US$10 billion hedge fund was rare; today there are 20 managers who run at least that much in assets. You can make T-bill returns and be just fine because you have a 2 percent management fee. Of course, some do deserve the pay scale due to the returns and terms of the agreement - e.g. Gendell made US$215 million in 2005 thanks to a 38 percent net return, which followed 100 percent-plus returns in 2003 and 2004.

The billions and billions of dollars being accumulated by hedge fund managers is a concern for investors. The wealth creates the potential for major distractions for all managers who are successful - wealth has the potential to have a dulling influence on a manager’s drive, you start buying your own Gulfstream, buy a small island off Tahiti, ... indulge in art, wine, women... maybe even fund a movie of your choice.... or give it all up to spend a couple of years in Nepal.

In every profession, whether it is a football coach or a surgeon, the best person makes the most money. The same is true with investment managers. The great ones are hedge fund managers. Why is that Tom Cruise gets US$20 million per movie and nobody says anything, or the US$6 million per movie by Nicole Kidman.... or the US$60 million dollar man Schumacher who doesn't know how to turn, park or drive.

1 - James Simons - Renaissance Technologies Corp. US$1.5 billion
Simons’ legend grows apace with his portfolio and his philanthropy. Last year the veteran Long Island hedge fund manager’s quant-driven Medallion hedge fund returned 29.5 percent net. That was all the more remarkable given the US$5.3 billion fund’s 5 percent management fee and 44 percent performance fee. (The gross return was nearly 60 percent.) Even so, Medallion fell short of its roughly 34 percent annualized net return since its 1988 inception. The odds are pretty good that Simons will figure out how to make up that shortfall. Many hedge funds are run by teams of pointy-headed rocket scientists, but Renaissance Technologies Corp. might be able to run its own space program. The 68-year-old Simons, who has a Ph.D. in mathematics from the University of California at Berkeley and has taught at Massachusetts Institute of Technology and Harvard University, has packed his East Setauket, New York, enterprise with math and computer whizzes. These quantitative specialists use arcane programs to trade the globe’s most liquid securities rapidly and frequently, using lots of leverage. Nonetheless, no program can entirely capture the markets’ vicissitudes. The firm’s new US$3.4 billion Renaissance Institutional Equity Fund, which Simons says in an investor document has the capacity to handle as much as US$100 billion in assets, got off to a slow start last year, rising just 5 percent from its August 1 inception through year-end. RIEF’s US$20 million minimum investment gears it to institutions; unlike the shorter-horizon Medallion, the new fund takes mostly long positions and holds them for relatively protracted periods. RIEF’s gain in assets came as Simons moved Medallion ever closer to being a closed portfolio for himself, his friends and his employees. Always generous, Simons is devoting a large amount of time and money to philanthropies near and dear to him. He has donated US$38 million to research the cause of autism, with which his teenage daughter was diagnosed when she was young. He and his wife, Marilyn, are said to be prepared to spend a further US$100 million on promising autism studies. Early this year Simons, who once chaired the math department at the State University of New York at Stony Brook, gave US$13 million to nearby Brookhaven National Laboratory so that it could keep running its Relativistic Heavy Ion Collider, the only device in the world that can mimic the “Big Bang” in the lab. Simons, along with a large number of other managers on our list of top money earners, is supporting New York State Attorney General Eliot Spitzer’s bid to become governor of New York.

5 - Paul Tudor Jones II - Tudor Investment Corp. US$500 Million
The Robin Hood Foundation’s annual benefit often brings out the quirkier sides of Wall Streeters along with their checkbooks. For last year’s gala Paul Tudor Jones II, a co-founder of the charity, dressed as Star Wars’ Darth Vader. “This is what will happen to you,” Jones, who is 51, warned traders under 40, according to those who were present. Going over to the dark side hasn’t hurt his performance. Since opening Tudor Investment Corp. in 1980, Jones has never had a down year. In 2005 the firm’s US$5.3 billion flagship Tudor BVI Global Fund climbed 14.7 percent net of its 4 percent management fee and 23 percent performance fee, marking its fifth year in a row of double-digit net returns. Most of the gains came from global equities, including macro bets in Japan, energy and emerging markets. (James Pallotta, No. 14, oversees Tudor’s Raptor funds and himself earned US$200 million.) Jones, whose Greenwich, Connecticut–based firm manages US$12.7 billion in all, is a staunch supporter of wildlife conservation. He owns Grumeti Reserves in Tanzania’s Western Serengeti and was recently lauded by the East African country’s Parliament for not permitting hunting in his reserve. He has given money to Democrats in key races in 2006, backing New York State Attorney General Eliot Spitzer’s run for the governorship of New York.

6 - Edward Lampert - ESL Investments US$425 Million
Time magazine, in its May 6 issue featuring “the lives and ideas of the world’s most influential people,” poses this question about one of its 100 profile subjects: Is Eddie Lampert the best investor on Wall Street? Lampert’s fund was up just 9 percent in 2005, chiefly because of a sizable cash position. As a result, he wound up taking home about US$600 million less than the more than US$1 billion he pocketed in 2004, when he was No. 1 on our list. All the same, Lampert’s investors have little to bellyache about. Even with last year’s listless showing, ESL Investments has compounded at about 28 percent a year, on average, since the 43-year-old launched it in 1988 at 26, fresh out of Goldman, Sachs & Co.’s risk-arbitrage group. ESL’s prospects now depend upon the health of mass-market retailer Sears Holdings Corp. Since Lampert took a recapitalized Kmart public in the spring of 2003, then merged it with Sears, Roebuck & Co. in mid-2005, his investment has soared tenfold. The company accounts for two thirds of Greenwich, Connecticut–based ESL’s US$11 billion equity portfolio. Sears’ shares finished last year up 16.8 percent. ESL’s other two big positions: a US$1.7 billion stake in car retailer AutoNation, whose shares rose 13 percent in 2005, and a US$2 billion investment in parts supplier AutoZone, which was flat. One question on the minds of Sears shareholders is what Lampert, who is chairman, plans to do with the US$4.4 billion sitting in its till. At Sears’ annual meeting in April, he hinted at additional acquisitions. Meanwhile, Lampert is battling New York–based hedge fund Pershing Square Capital Management for control of Sears’ Canadian operation (Sears Holdings owns a majority stake).

14 - Timothy Barakett - Atticus Capital US$200 million
For an activist investor, Timothy Barakett kept a low profile after launching Atticus Capital in 1995, at age 26. That changed last year when Atticus and the Children’s Investment Fund U.K., a London hedge fund, teamed up to block Deutsche Bšrse’s US$2.5 billion bid for the London Stock Exchange. They proposed instead that the German market issue a special dividend or buy back shares. Six months later Deutsche Bšrse’s CEO, Werner Seifert, quit, and the LSE has become the object of ardent courtship by both the Nasdaq Stock Market and the New York Stock Exchange. Then the battle-hardened Atticus turned on another exchange. Earlier this year the New York firm and accounts it advises amassed a 9.1 percent stake in Euronext and urged that the Paris-based electronic exchange combine with Deutsche Bšrse. In February, Barakett fired off a letter to Arcelor CEO Guy DollŽ expressing his extreme disappointment that the Luxembourg-based steelmaker, in which Atticus has a 1.3 percent stake, wasn’t paying more attention to a tender offer from Mittal Steel Co., also based in Luxembourg. Barakett, who holds a BA in economics from Harvard University and an MBA from the Harvard Business School, does not make his rather handsome living just from badgering CEOs. His Atticus Global fund was up a net 22 percent in 2005, and his Atticus European fund — managed by David Slager, who is tied for No. 20 — surged 62 percent. On a capital-weighted basis, Atticus’s funds were up 45 percent, on average. Little surprise, then, that the firm’s assets more than doubled in 2005, to US$9.2 billion. That must please Barakett, but it is also gratifying to Atticus vice chairman Nathaniel Rothschild, son of Lord Jacob Rothschild. The younger Rothschild earned about US$80 million last year.

20 - Daniel Loeb - Third Point US$150 Million
Daniel Loeb puts the “pistol” in epistolary. The Third Point founder’s letters to CEOs can be blunt, as in a blunt instrument. In one guided missive in February 2005, he wrote Irik Sevin, then CEO of Stamford, Connecticut– based heating-oil distributor Star Gas Partners: “Sadly, your ineptitude is not limited to your failure to communicate with bond and unit holders. A review of your record reveals years of value destruction and strategic blunders which have led us to dub you one of the most dangerous and incompetent executives in America.” Three weeks later Sevin resigned. But for all his bluster, the 44-year-old Loeb dedicates less than 10 percent of his New York firm’s US$3.8 billion in assets to shareholder-activism strategies. Instead, the 1984 Columbia University economics grad is a traditional value and event-driven investor. Last year Loeb cashed in on surging energy prices. He racked up big gains on two Houston-based energy companies — 140 percent on McDermott International and roughly 50 percent on Plains Exploration & Production Co. His return for the year: 18 percent net. In a more serendipitous investment coup, Loeb made a 500 percent profit in 2005 by selling a 1984 Martin Kippenberger painting that he had held for three years to advertising figure Charles Saatchi for $1.5 million. The hedge fund manager owns more than 30 works by the German artist, whose credo was to shock and disturb people to expand their perception, not unlike Loeb.

Top Ten:
1. James Simons $1.5 billion Renaissance Technologies
2. Boone Pickens $1.4 billion BP Capital Management
3. George Soros $840 million Soros Fund Management
4. Steven Cohen $550 million SAC Capital Advisors
5. Paul Tudor Jones $500 million Tudor Investment
6. Edward Lampert $425 million ESL Investment
7. Bruce Kovner $400 million Caxton Associates

8. David Tepper $400 million Appaloosa Management
9. David Shaw $340 million D.E. Shaw
10. Stephen Mandel $275 million Lone Pine Capital

1 comment:

Moola said...

Hi Sal,

There was an article on the NY Times which spoke about the other side of the fence:

Where are the "alpha" generators, those that are supposed to create performance above the market? (Market returns are called beta.) From May 1 through May 19, the Standard & Poor's 500-stock index dropped 2.9 percent. The Chilton Opportunity International Fund, a mid-small-cap equity long-short fund, fell 4.73 percent through May 19 and 1.35 percent for the year. The Zweig-Dimenna International fund, also a long-short fund, lost 4.45 percent for the month through May 19, totaling a 4.06 percent gain for the year. The GLG European Long-Short fund fell 5.13 percent through May 19, posting a 13.70 percent gain for the year.

Some hedge fund stars got hit, too: Viking Global Equities III was down 2.06 percent for the month through May 19 and Maverick Fund Ltd. Class A, run by Lee Ainslie III, was down 2.31 percent for the month through May 19.

To be fair, one month of data is not an indication of how closely a fund is tied to a particular market or how that fund will perform for the year. Any number of things can happen to turn around the performance. But the question that many investors should be asking is: Am I getting alpha or beta? And if the answer is beta, why the high fees?

Simply put, hedge funds that claim they are not correlated to the markets should not be correlated to the market. In bull markets, investors do not question correlation.

"Long-short equity funds, in the aggregate (plenty of individual exceptions where this does not apply) are consistently long more then they are short, and get longer after the market has been going up (and vice versa)," Clifford S. Asness, founder of AQR Capital Management, wrote in an e-mail message. "This protects capital well in long-slow declines, but not in crashes (it's kind of like the old portfolio insurance strategy)."

Some managers will shine. The business was born of investors who make big bets in turbulent times and end up making a killing. Take Paul Tudor Jones II. Since opening Tudor Investment in 1980, he has never had a down year, according to Institutional Investor's Top 25 best-paid managers list.

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