Careers in Finance: Hedge Funds

Landing at a hedge fund is one of the most lucrative career paths one can hope for in finance. With institutional and individual investors clamoring for risk-adjusted returns, tremendous liquidity from global central banks, and one of the longest running bull markets in history, the hedge fund industry has ballooned to over $3 trillion of assets1. Here are some frequently asked questions regarding hedge funds for those interested in pursuing careers in finance.

What are Hedge Funds?

Hedge funds are private investment partnerships that manage pools of capital with few constraints with regard to investing style. Hedge funds can be viewed as an alternative asset class because they employ many different investing strategies including long/short, distressed debt, arbitrage and credit enhancement. Hedge funds can basically invest in anything, anywhere in the world, from foreign currencies and commodities to life insurance claims and wireless spectrum. Adding a hedge fund that is uncorrelated or negatively correlated to your portfolio reduces the overall risk in a portfolio, even if the hedge fund itself is risky.

Compare this to a mutual fund which is typically “long only”, meaning it uses almost all of its investor’s capital to buy and hold stocks. Hedge funds can buy stocks but they can also do things mutual funds are mostly prohibited from, including short-selling stocks (betting against a stock’s performance by borrowing shares of stock from a bank and selling them without actually owning them), employing huge amounts of leverage (sometimes 30 to 1) and using complex derivative strategies to ‘hedge’ other holdings. Another difference is the investor’s money is usually ‘locked up’ for a specific period (ranging from 3 months to 2 years) a holding period commitment where they can’t access their money. Hedge funds are often structured as limited partnerships and some investors actually become new limited partners. But hedge funds cap the number of investors in the fund, unlike a mutual fund.

Who Invests in Hedge Funds?

Many large institutions include hedge funds in their asset allocation strategy for their risk-adjusted returns. These include corporate and public pension funds, foundations and endowments. Together, these institutions account for almost 2/3 (65%) of assets invested in hedge funds by North American investors, according to Pensions & Investments online2. With the low interest rate environment lasting longer than many expected, pension funds have poured money into hedge funds to close the funding gap they face for their beneficiaries (current and future retirees).

Hedge funds are not directly available to the public. An individual investor must be ‘accredited’ (‘sophisticated’, defined as having a high liquid net worth) to show that they understand that investing in hedge funds could involve significant risk and are less regulated than many other investment vehicles. Additionally, an investment in a hedge fund may not be covered by SIPC, the Securities Investor Protection Corporation, unless the hedge fund is registered with the SEC (Securities and Exchange Commission). Conversely, if you have a regular brokerage account and they face financial trouble (like Lehman Brothers or Bear Stearns) your portfolio holdings would be covered up to $500,000, similar to the way FDIC insures depositors up to $250,000 in the event of a bank failure.

Still, this alternative asset class has grown from the world of obscurity just a couple decades ago to becoming common vernacular for investors. Relaxed advertising regulations and increased availability directly through brokers have allowed more and more people find their way into hedge funds. For example, as they say on their commercials, Interactive Broker’s Market Place website lists hedge funds they partner with. Some hedge funds have even gone public so, indirectly, anyone can participate in this industry (usually the management company of the fund goes public). Large hedge funds like Fortress Investment and Och-Ziff Capital currently have publicly traded securities.

What are the Different Jobs within a Hedge Fund?

There are different opportunities one can seek out at a hedge fund. Many people out of business school aren’t too particular about what role they play if offered a position. Here are some of the front-office jobs people exploring careers in finance might consider (we’ll exclude the funds principals since these are often the founders or original seeders of the fund).

Analysts 

Hedge fund analysts are charged with scouring all sources of information and provide ideas for the traders and portfolio managers. They often communicate with Wall Street analysts who provide the fund with research if the fund is covered. Analysts may also establish or work with expert networks if they attempt to delve deep into one particular industry. There is also significant traveling to conferences or meetings with different corporate managements (sometimes coordinated by sell-side analysts). Unlike Wall Street analysts, the hedge fund analyst’s research is usually proprietary and kept for their own internal use.

Portfolio Managers

Portfolio managers know how to put the ideas the analysts provide them together to perform whatever strategy the fund may be employing at the time. It can be risk reduction or high beta (risk). Normally, these are your more experienced industry professionals (many are former analysts) and they often enjoy some of the highest compensation in the fund, outside of the principals.

Business Development

Business development employees are essentially the capital raisers for the fund. They do lots of traveling in an effort to raise capital for the hedge fund, often giving presentations and establishing and maintaining relationships with clients as well as other hedge funds (if they run a ‘fund of funds’). Often, these may be former Division-I athletes and impressive Type-A individuals. But there is a trend towards outsourcing this role and specialized outside firms come in to handle the capital introductions.

Traders

Traders are extremely important for the hedge fund as they actually execute the trades for the fund. Poor trade executions can negate a great idea. Often traders have been lured away from Wall Street sell-side firms. The compensation is all over the place for traders but can be extremely high. Unfortunately, so is job insecurity if you don’t perform well.

What’s the compensation at a hedge fund?

Why do so many new MBAs want to work for hedge funds? In a word, money. Profitable hedge funds can be very lucrative. A hedge fund traditionally charges it’s investors a ‘management fee’, often 2% of assets managed, plus a ‘performance fee’ of 20% of the profits. That’s a lot of money flowing through the fund to be used for compensation. Even if the fund loses money one year, it doesn’t collect the performance fee but still receives the 2% management fee. Of course, the more down years the fund has, the more investors will pull out their money.

Hedge fund employees also make out well. The average total compensation for a hedge fund professional in 2015 was $368,000 according to the 2015 Hedge Fund Compensation Report, although the dispersion of results is wide.3 But a 2014 report by SumZero indicates that total compensation cracks that $200,000 level (both on average and median bases) after 4 or 5 years of experience in the industry.4 This same 2014 report showed a total average annual compensation package had increased to $409, 826, speaking to the positive momentum in financial markets for that time period. The higher your compensation goes, the larger percentage you can expect to receive in deferred compensation or equity of the firm, not cash, keeping more employees with ‘skin in the game’. Hedge funds offer a higher ceiling than probably any other financial area.

But this higher pay comes at a price. The 2015 Hedge Fund Compensation Report revealed that almost 80% of hedge fund professionals work between 40-60 hours per week.5 And the jobs can be extremely stressful coupled with questionable job security, especially if the firm has a bad year.

Hedge fund managers are often larger than life characters you might see in movies like Wall Street or television’s Lifestyles of the Rich and Famous. Titans of the hedge fund world include George Soros, Bill Ackman and Ray Dalio who have all made over one billion dollars in a single year. Here are the top 5 earning hedge fund managers in 2014 according to Forbes.6 (Steve Cohen would have topped this list at $1.3 billion in compensation for 2014 but his Point72 Asset Mgmt. is technically a family office).7

Fund Manager Firm Name Assets Under Mgmt. 2014 Earnings
Ray Dalio Bridgewater Associates $155 billion $1.2 billion
George Soros Soros Fund Management $30 billion $1.2 billion
Ken Griffin Citadel, LLC $26 billion $1.1 billion
Bill Ackman Pershing Square Capital $18.5 billion $1.1 billion
James Simons Renaissance Technologies $27 billion $1.1 billion

How do I get hired by a hedge fund?!

Getting a job at a hedge fund isn’t easy, but having an advanced degree certainly increases your chances. Still, sometimes it’s more about who you know than what you know. MBA programs, especially ones with a concentration in finance, are great networking opportunities, an often underappreciated benefit. Tap into your alumni network and career services. While the top hedge funds may be very selective in hiring, with an estimated 10,000 hedge funds in operation, there are plenty of opportunities.

1https://www.evestment.com/resources/research-reports/2014-research-reports/global-hedge-fund-asset-flows-report—may-2014
2http://www.nepc.com/writable/research_articles/file/nepc_2015_odd_survey_summary_copy1.pdf
3https://www.evestment.com/resources/blog/corporate-blog/2015/01/09/2015-hedge-fund-compensation-report-reveals-higher-salaries-bonuses
4http://www.businessinsider.com/how-much-people-make-at-hedge-funds-2014-4
5http://hedgefundcompensationreport.com/executive-summary/
6http://www.forbes.com/hedge-fund-managers/
7http://www.forbes.com/profile/steve-cohen/