2 Hedge Fund Compensation Structures that Make More Sense Than 2 & 20

Nathan Anderson | August 17, 2015

1. Performance fees vest over 5 years  —  Attrition in the hedge fund industry is high for a reason—funds have an incentive to “go big or go home”. The standard 20% of annual profits approach rewards high risk-taking. If funds (and their investment staff) are given a vesting schedule on performance fees and bonuses this will align manager behavior with longer-term oriented investors. So instead of paying the full 20% at the end of year one, pay 1/5th of those profits each year over a 5 year period, subject to withholding if subsequent year performance is down.

2. Tie Performance Fees to Fund Objectives  —  This sounds almost sarcastically obvious but this is actually not the standard in the industry. If a long/short fund runs a net long book and the S&P is up 30%, the fund is in a position to reap a substantial reward no matter whether they generated alpha. Not every hedge fund is designed to be an absolute return vehicle. Many are meant to provide better risk adjusted returns relative to the market, or some are meant to outperform benchmarks on an absolute basis. A fund should be clear with their objectives and tie their performance directly to those objectives.

Have other ideas? Leave them in the comments or contact us.

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Nathan Anderson

Nate co-founded ClaritySpring and oversees the company's strategy and operations.

1 comment

  • Ray Dragunas - May 1, 2016 reply

    Nathan,

    I know this article is from last year, but I quite enjoyed it and others on your site.

    As an emerging manager, the vesting idea absolutely the way to go these days. In fact, I would take it one step further and have the bonus invested in a phatom plan to truly align the manager and the investor.

    We have see enough of the leveraged beta managers shear investors and others completely blow ups.

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