Why are Hedge Fund Managers so Rich?

Why are Hedge Fund Manager so Rich?

Have a look at the list of the wealthiest people in NYC? You can find many hedge fund managers are worth many millions and sometimes billions like James Simons of Renaissance Technologies, George Soros of Soros, etc. Why are Hedge Fund Managers so rich? While pondering the question, you realize that the pay gap is so huge that it has become a much sought out job for those in the financial sector.

Hedge fund managers become rich by making money on the profits of their assets. They charge a 2% performance fee and cut the generated gains, which amounts to about 20%. Due to the above, they only allow wealthy and affluent individuals to invest in hedge funds. 

There is one more thing you need to realize; Not all hedge fund managers earn so much. The ratio mentioned is a ballpark figure and doesn’t work the same every time. It is a flat rate that applies only for average gains, but their cut reduces when the profits are meager.

How does a Hedge Fund Earn Money?

Before touching on how the highest-earning hedge fund managers succeed in making so much money, you need to know about hedge fund profits . They do so by charging a performance fee and an asset management fee. It varies depending on the fund, but the percentage is 20% and 2% approximately.

While the above figure seems high, it protects the investors when the funds start losing money. The losses are carried forward with the proviso that the funds make back the lost money.

Asset Management Fee

The management fee is a percentage of the assets that the firm manages. These fees are paid regularly, either monthly or quarterly, and vary according to the firm and client. They charge about 2% as a standard but can get as low as 1% and as high as 4% based on their assets. It goes towards the firm’s general running, including daily expenses, hedge fund salary, and the overhead capital.

Performance Fees

The performance fee is calculated from the profit generated by the funds. So, as long as the funds generate profit, they earn a percentage. If it doesn’t perform, they get nothing. This fee is more of an incentive that encourages the managers to perform well and generate excellent returns. It is usually used to pay bonuses and reward the staff for performing well on the account.

Earning Capacity of the Managers

According to a survey, the top hedge fund managers of 2017 earned more than a billion dollars each, with the least earning manager (at position 25) pocketing 200 million dollars. While the average earning of them lingered at $350,000, not all made the same. The income depends on the experience; for someone with 20-25 years of experience in the industry, they can make anywhere from $260,000 to $705,000.

2 and 2 Rule

As discussed above, hedge funds operate by the 2 and 20 rule by which the funds get 2% of the assets no matter if they are performing well or not. However, in case they perform well, they get an additional 20% of the gains. This structure is widely criticized since the managers get a princely sum of money from the funds even if they are losing money.

A manager who has billion-dollar assets under him gets around 20 million dollars without even working for it. If the investments perform well in the market, they get to make more.

However, the catch is when the funds are losing money; They then have to explain the clients’ losses while the managers are getting paid as usual. As much as this situation is awkward, it is not uncommon.

What Does a Manager Do? 

The earning capacity of a hedge fund manager raises the question, what do hedge fund managers do? The primary responsibility of a manager is to find investors and get them successfully onboard the firm. When the clients are ready to work with the firm, the next part of their duty starts, which is to look for appropriate investment opportunities.

They also study the financial market, understand the current trend, and make investment plans accordingly. They also have to keep an eye on the stock market, analyzing the fluctuations while networking all the time. As they rise above ranks, they can put in a workweek of 100 hours to stay ahead of the competition. For all it is worth, they make a lucrative living.

Related Q&A

Who is the highest-paid hedge fund manager?

Chase Coleman, the founder of Tiger Global Management, is worth $6.9 billion and tops the highest-paid list according to Forbes. Jim Simons from the trading firm Renaissance Technologies is worth $23.5 billion and is the richest, though he retired from the scene about a decade ago.

Do hedge funds ever lose money?

Only a handful of the hedge funds perform great and have done exceptionally well for their clients. Whether they can continue to do so is the question. However, in most cases, hedge funds charge more for below-average performance. So, yes, hedge funds lose money, but mostly, the clients cover all the losses.

What makes a good hedge fund manager?

A good manager should be able to perform consistently and generate good gains continuously. To achieve that, they should have the following traits:

  • Sound technical knowledge
  • Marketing strategy
  • Good decision-makers
  • High emotional stability
  • Discipline

Why are Hedge Fund Managers so Rich – Conclusion

Being a hedge fund manager is not fun; it is tiring work with long hours, but the high pay makes it worthwhile. Not all funds perform well, and indeed, not all managers earn as high. But as the years go by with experience, you can certainly crack the code.

The managers get paid on a 2 and 20 structure where they earn a 2% management fee irrespective of profit or loss and a 20% performance fee if the funds perform well.

Hedge funds do not allow anyone and everyone to invest. You should be worth at least $1 million or draw a salary of $200,000 per year for two consecutive years to be able to invest. The stakes are high, but they give a high return.

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