The Terabyte Has Landed!
Hedge Funds: Two-and-Twenty

Simons, Griffin, Lampert, Soros, Cohen, Kovner

Two-and-twenty: two percent of assets under management, plus twenty percent of the (nominal) return on assets. That is said to be the typical fee charged to a hedge-fund investors. In an environment of 3% annual inflation and a 5% annual net real S&P index fund return, a hedge fund team has to deliver an average gross nominal return of 12% per year without taking on more systematic risk than the S&P in order to offer its investors a good deal. This is very hard to do.

Nevertheless, some people are doing it, and doing it repeatedly--or are doing it now, as long as they don't hit the tails of their portfolios' return distributions:

Top Hedge Fund Managers Earn Over $240 Million - New York Times: By JENNY ANDERSON and JULIE CRESWELL: James Simons, a 69-year-old publicity shy former math professor, uses complex computer-driven mathematical models to make bets on stocks, bonds and commodities, among other things. His earnings last year were $1.7 billion. As one of the leading hedge fund managers, Mr. Simons makes a sum that dwarfs that of the top chiefs on Wall Street. The highest paid on the Street, Lloyd C. Blankfein of Goldman Sachs, earned $54.3 million in salary, cash, restricted stock and stock options last year. (Unlike the total for Mr. Simons, Mr. Blankfein’s reported compensation does not include gains on investments.) And Mr. Simons, the founder of Renaissance Technologies, is not the only member of the billion-dollars-a-year club.

Two other hedge fund managers, Kenneth C. Griffin and Edward S. Lampert, each took home more than $1 billion last year, with George Soros missing the hurdle by a hair, give or take $50 million, according to an annual ranking of the top 25 hedge fund earners by Institutional Investor’s Alpha magazine, which comes out today. The rewards for managing hedge funds — lightly regulated private investment pools for institutions like endowments and wealthy individuals — have been lucrative for some time. Yet the survey also shows that for the hedge fund elite, the rich are getting much richer in a hurry. To make Alpha’s list, a manager needed to earn at least $240 million last year, nearly double the amount in 2005. That is up from a minimum of $30 million in 2001 and 2002. Combined, the top 25 hedge fund managers last year earned $14 billion — enough to pay New York City’s 80,000 public school teachers for nearly three years.

With the modern gilded age in full swing, hedge fund managers and their private equity counterparts are comfortably seated atop one of the most astounding piles of wealth in American history. Their ascendancy has been aided by an inflow of money from pension funds and other big investors, robust markets and fee-based compensation that can produce staggering amounts of individual wealth. Naturally, some look upon these masters of the new universe as this generation’s robber barons, using wealth to create wealth, often in secretive ways, and leaving little that is tangible in their wake. Others view them as new-economy financiers, evoking the likes of John D. Rockefeller or John Pierpont Morgan as they provide liquidity to the markets and broadly diversify risks in the banking and financial systems.

“You had railroads in the 19th century, which led to the opening up of the steel industry and huge fortunes being made,” said Stephen Brown, a professor at the Stern School of Business of New York University. “Now we’re seeing changes in financial technology leading to new fortunes being made and new dynasties created.” But as hedge funds and their private equity brethren begin to emerge more onto the public stage — playing increasingly bigger roles in art and cultural circles, tiptoeing into the Washington lobbying game, and even selling shares of their own firms to the public — all aspects of their activities, their own compensation in particular, are raising eyebrows.

“There is some question as to what the hell they are doing that is worth” that kind of money, said J. Bradford DeLong, an economist at the University of California, Berkeley. “The answer is damned mysterious.”...

While the debate rages, the new financiers are building up piles of money not seen since the heady days of the Internet boom. But unlike the wealth of many dot-com billionaires, who saw their fortunes collapse with the technology bubble, the gains of hedge funds are not simply returns on paper that fluctuate with the direction of the stock market. Instead the gains are huge cash payouts that most managers then reinvest in their funds, betting that they will continue to beat the markets. Still, the performance of these managers is as varied as their strategies, ranging from complex computer models to the more old-fashioned version of betting the farm on a few stocks. None of the managers contacted for this article returned calls or would comment....

Raymond T. Dalio, head of Bridgewater Associates, which has more than $30 billion in hedge fund assets, for example, took home $350 million last year even though his flagship Pure Alpha Strategy fund posted a net return of just 3.4 percent for the second consecutive year....

Mr. Simons, a former code breaker for the Defense Department, uses computer-driven models to detect pricing anomalies in stocks, commodities, futures and options. Even though he has some of the highest fees in the business — 5 percent of assets under management and 44 percent of profits — he trounces most of his competitors year after year. In 2006, the $6 billion Medallion fund posted gross returns of 84 percent; 44 percent after fees, explaining his $1.7 billion take. Some investors do not blink at paying those startling fees. “If you pay peanuts, you get monkeys,” said Jim Dunn, a managing director with Wilshire Associates, an investment advisory firm. “We don’t concern ourselves with fees. If you can provide Alpha, I’m less concerned about what you bring home.”...

[T]he hedge fund age illustrates that experience indeed pays. The average age of Alpha’s top 25 was 51, with only four thirty-somethings on the list. Among them is John Arnold, the 32-year-old from Centaurus Advisors who amassed net gains of 200 percent last year. Mr. Arnold hails from Enron’s energy desk, where he received a lifetime of trading and other experiences. His $3 billion fund, among the largest energy funds in the world, racked up huge gains by taking the other side of a natural gas bet that caused Amaranth to lose more than $6 billion in a week. But older, more familiar names dominate Alpha’s list. Boone Pickens, the 78-year-old oil tycoon, made $340 million on the back of strong returns at his energy funds and Carl C. Icahn, 71, the reborn activist investor, made $600 million...

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