Equity sharing is an important variable to consider in determining the level of total compensation an individual will receive from his hedge fund firm. While equity or upside sharing is not a topic typically perceived as applicable to those just beginning a career in the hedge fund field, it ultimately becomes incredibly important to the overall earnings trajectory of every hedge fund professional.
What Is Equity Sharing?
Upside sharing, a term often used in the hedge fund industry is difficult to explain definitively. The 2016 Hedge Fund Compensation Report explains upside sharing in greater detail, and includes survey data acquired from participating hedge fund professionals. In the space allotted here, it is sufficient to say that each hedge fund’s approach to equity or upside sharing is unique and no established model for upside sharing exists, although they do share some commonalities.
It is important to understand that upside sharing is different than bonus pay. Equity sharing is frosting on the bonus cake. Because performance fees are the source of funds for equity sharing, a fund that underperforms will not produce the revenue needed to pay out equity shares. Consequently, upside sharing is the carrot of choice to dangle before the hungry mouths of those in the firm who have the greatest responsibility for making investment decisions.
Who Benefits from Equity Sharing?
Of course, those receiving an equity share benefit financially, but, in truth, the hedge fund’s investors are the supreme beneficiaries, because the practice incentivizes prudent investment decisions. Additionally, upside sharing ensures the stability of the investment team. This is extremely important to hedge fund firms and investors because, turnover and instability can impact hedge fund returns as much as deficiencies in skill and experience.
Who Gets an Equity Share?
According to the previously referenced report, 75 percent of hedge fund professionals do not receive an equity share. Of the remaining 25 percent, more than one-half receives an equity share of less than two percent. Only six percent receive an equity share greater than 10 percent. Clearly, nothing says “you’ve made it” in quite the same way as garnering an equity share.
As mentioned earlier, those breathing this rarefied air are typically those shouldering the most responsibility for the firm’s investment decisions. Leading the pack is the Chief Investment Officer, Partner/Principal and Managing Director. Work experience also plays a significant role. For example, of those with more than 20 years of experience, only 40 percent receive an equity share.
While upside sharing may not be of immediate concern for hedge fund novices, it is an integral component of hedge fund compensation and becomes increasingly important as one’s career progresses. It should be apparent that a hedge fund firm’s upside sharing policies and practices can provide valuable insights regarding many aspects of the firm, not the least of which is the value a firm places in its investors and employees.
The question begging an answer is whether declining equity participation is driving poor performance or, is poor performance driving the shrinking number of hedge fund professionals receiving an upside share.