Down But Not Out at $464 Million a Year
Not everyone in the international hedge fund industry is making millions. Not everyone in the hedge fund industry right now even has a job. Amid the worst global economic meltdown since the Great Depression, hedge funds are hemorrhaging positions. An estimated 20,000 will be gone by year's end.
But the hedge fund industry still does have something no other industry in the known universe can match: the best-paid top executives who ever lived.
"These are the highest earners," as Manhattan College financial historian Charles Geisst put it last week, "of all time."
That observation came right after Alpha, the hedge fund industry trade journal, reported that the hedge fund industry's top 25 managers added $11.6 billion to their personal fortunes in 2008, an average of $464 million each, the third-highest top 25 total since Alpha started keeping score in 2002.
How did the movers and shakers of hedge fund land work such magic? For the most part, we simply don't know. Hedge funds, as largely unregulated entities, don't have to reveal almost anything about how they go about their business.
The most secretive hedge fund manager of them all, James Simons of Renaissance Technologies, netted $2.5 billion last year. One of the funds Simons manages generated a 160 percent return in 2008, through some financial alchemy that observers, in the absence of any real information, have taken to describing as "computer-driven trading strategies."
The number two on this year's hedge fund top 25 we know more about. John Paulson of Paulson & Co. has made his big money -- $2 billion in just 2008 alone -- by betting that the incredibly overinflated market for subprime mortgage-backed securities would tank.
Paulson no doubt understands the lucrative irony behind his enormous personal windfall. His colleagues in the hedge fund industry helped inflate the market for subprime securities in the first place.
Fifty years ago, in a more equal America, hedge funds as we now know them didn't exist. They didn't explode onto the financial scene until the 1980s, when the Reagan revolution was rapidly concentrating income and wealth at the top of the U.S. economic ladder.
America's newly flush rich, their pockets bulging, had plenty of cash to invest, and the emerging new hedge funds -- pools of investment capital open only to deep-pocket investors -- promised better returns than those deep pockets could get anywhere else.
Hedge fund managers, needing to deliver on those promises, hungered mightily for high-return investment opportunities that could keep their wealthy clients happy. Traditional Wall Street investments -- corporate stocks and bonds -- couldn't deliver the high returns the hedge funds needed. But the financial world's new-fangled "derivatives" could.
These increasingly exotic financial instruments, all based on the endless repackaging of ever-shakier mortgage loans and consumer debt, would find an eager hedge fund market. Hedge fund dollars, in effect, kept the U.S. economy blowing bubbles.
The bubbles all burst in 2008, and the hedge fund industry has certainly felt the aftershock. Over 900 hedge funds, about 14 percent of the fund total worldwide, shut their doors last year. The industry ended 2008 with assets down 37 percent, over $700 billion, from the industry peak last June.
But that downturn left an estimated $1.2 trillion still sloshing in hedge fund coffers, more than enough to power top hedge fund execs to another round of windfalls.
These top execs typically charge investors a fixed percentage of the billions in assets they manage, usually 2 percent. The celebrity hedge fund managers charge even more. James Simons, for instance, levies a 5 percent management fee on the billions investors turn over to him — and then takes a 44 percent cut on any profits he makes selling the assets he buys with those investor billions.
In 2008, you didn't have to be a hedge fund celebrity like Simons to score big. Even junior hedge fund analysts did quite wonderfully, given the economic tenor of our times. They averaged $195,520 last year, says the trade journal Alpha.
Industrywide, hedge fund jobs paid an average $794,000 in 2008, down from $940,000 the year before. U.S. Treasury Secretary Tim Geithner last week unveiled a plan that will hand hedge funds and other big investors a subsidy worth as much as $1 trillion to start buying up the toxic derivative securities that now have no little or market value.
If Geithner's plan works, hedge funds will take those tax dollars and jumpstart the market for toxic securities, the securities will rise handsomely in value, and hedge fund managers will reap still more jackpots.
But some financial insiders like venture capitalist and commentator Peter Cohan don't believe Geithner's plan will work. A good many hedge fund managers won't play ball with Geithner's new plan, Cohan predicts, "because they fear that there'll be a public outcry over their compensation if the plan makes them even richer."
And if that outcry gets loud enough, the hedgies no doubt worry, lawmakers may feel compelled to shut the loophole that lets hedge fund managers claim much of their income as capital gains. That neat trick lowers the tax rate on a hefty chunk of hedge fund manager earnings from 35 to 15 percent.
The cost to taxpayers? The hedge fund loophole, the Institute for Policy Studies in Washington, D.C. estimates, is running taxpayers about $2.7 billion a year.