Hedge Fund Investors Quit Paying for Beta

Capital and compensation tracked hedge fund performance more closely in 2012 than years prior, according to fresh industry data.

(March 15, 2013) - Last year was an active one for hedge funds: assets hit a record high, bonuses surged by an average of 31%, and yet more funds shut their doors than any time since 2009, according to just-released data.

The shifts in capital flow, compensation, and liquidation spoke to a broader trend in the hedge fund space: greater accountability for performance.

Industry-wide assets under management reach a record peak of $2.5 trillion at the close of the 2012 calendar year, according to a Hedge Fund Research (HFR) report. The firm's weighted composite index gained 6.37% in 2012-well under the S&P 500's 15.99%--but performance varied widely by strategy. Asset-backed fixed income funds stole the show with indexed returns of 17.22%, while managers shorting equity markets came up...short. The HFRI short-bias index lost 17.24% in 2012-far more than the next-weakest performer, energy and basic materials (-5.69%).

Capital tracked performance, for the most part. Relative value strategies as a group, which includes all of the fixed-income focused funds, outperformed HFR's other strategic groupings (macro, equity hedge, event-driven, and fund of funds). Likewise, relative value funds' net asset flow was by far the strongest, adding $41.4 billion over the year. The data shows that investors recoiled from equity hedge funds, which include the unenviable short bias managers, and pulled out $10 billion more than they invested.

Managers still need more than just the strategy du jour to persuade investors to open their wallets, according to HFR's President Kenneth Heinz. "In order to raise new investor capital, hedge funds must not only demonstrate both superior performance and an innovative strategy," he said, "but also increased organizational efficiencies of competitive fees, transparent structures, sophisticated risk management and satisfaction of extensive institutional due diligence processes."

Just as with capital flow, hedge fund compensation rose overall but was increasingly correlated with manager performance, according to the 2013 Hedge Fund Compensation Report, released today. 

"This year, we discovered a significant correlation between fund profitability and bonus size," said David Kochanek, publisher of the report, which is based on data collected from hundreds of portfolio managers across a swath of funds. "Employees of the best-performing funds took home average bonuses of just over $200,000. Given similar performance, we expect 2013 bonuses to rise even further as many funds will reach their high-water mark."

During a recent interview, one member of the upcoming Forty Under Forty list echoed a common sentiment among asset owners regarding manager compensation: "We don't want to compress fees because we're being cheap; we want to align interests. Nobody minds paying for performance."