Managing Pretty Well Without Performance Fees

By Amanda Cantrell

With investment bankers enduring layoffs, smaller paychecks, media criticism and scrutiny from regulators over the past few years, it’s no surprise that hedge funds are an ever-more-popular career choice for would-be financiers. Another big draw for the industry? Performance fees.

That’s because these fees, typically 20 percent of a firm’s assets under management, can make managers spectacularly wealthy when a hedge fund hits its marks. But when that fund is losing money, managers can’t charge these fees, and that makes it harder to keep the business going.

Enter the humble management fee. Originally envisioned by hedge fund managers as a source of income that would cover the costs of running their businesses in good times and bad, the management fee — which generally falls somewhere between 1 and 2 percent of assets — has become a lifesaver for firms during lean years. But lately, it’s been helping managers do a lot more than survive. Last year management fees at some of the biggest hedge funds in the business helped their founders make hundreds of millions despite modest performance. In our 11th annual Rich List of the world’s top hedge fund earners (page 36), 11 managers made the cut after generating only single-digit returns in their funds in 2011, thanks in large part to management fee income. Although the highest earners — Ray Dalio, Carl Icahn and Jim Simons — benefited from stellar returns, plenty of others did more than fine with far less impressive gains.

Small wonder, then, that management fees at hedge funds appear to be climbing, while performance fees are falling (see story, page 10). Though hedge funds are off to a good start this year — they earned 3.17 percent in the first two months of trading, according to the AR Composite Index — if performance continues to moderate, the much-vaunted performance fee could take a backseat to its humbler cousin. The performance fee may be what pulls people into the industry, but the management fee may well end up keeping them there.