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In a year when hedge funds significantly underperformed the broader S&P 500 index, it is not uncommon for one to think that even the best paid hedge fund managers would see a drop in their earnings.  But while the compensation of hedge fund managers across the industry as a whole may have remained subdued, the returns-based compensation structure of fund managers resulted in the best performing managers raking in huge payouts last year.  According to Institutional Investors’ Alpha, the top 25 hedge fund managers earned $21.15 billion last year, a whopping 50 percent increase over 2012.

Tepper, Cohen Top “The Rich List”

Top among the list was David Tepper, founder of Appaloosa Management, who took home $3.5 billion. Tepper was also the highest earning manager in 2012. He founded Appaloosa in 1993 after working at Goldman Sachs. His two main funds returned a combined 42 percent last year on accurate wagering on the recovery of the US airline industry.

Second in the list is Steve Cohen of SAC Capital Advisors, who was fined last year a record $1.8 billion in an insider trading case and ordered to close his fund to outside investors. Unlike the typical 20 percent performance fee charged by most funds, Cohen takes a 50 percent cut on the returns. He made $2.4 billion last year on the back of a 20.5 percent gain on its multi-strategy fund last year.

Other big winners include John Paulson who came in third with earnings of $2.3 billion. Paulson made a name for himself in 2008 when he reaped big gains by betting against mortgages. James Simons, who previously ran Renaissance Technologies, was ranked fourth with $2.2 billion. He is the only manager to make the list in all the 13 years that Institutional Investors’ Alpha has been tabulating it. Kenneth Griffin of Citadel completed the top five with $950 million in earnings.

Activist investor Dan Loeb also figured in the top 10 list. He earned $700m last year and was placed ninth.

Exclusions and First Time Entrants

Every year Institutional Investor’s Alpha produces “The Rich List”. It does not include fund managers who manage only family money. Billionaire investors Carl Icahn and George Soros did not figure in the list since they both have stopped taking outside money.

In all, 20 managers in the top 25 list also appeared on last year’s list. Three hedge fund managers broke into the list for the first time. They are David Einhorn of Greenlight Capital, Jonathan Jacobson of Highfields Capital, and Nelson Peltz of Trian Partners.

Relevance to Job Market

The compensation of top earning hedge fund managers has little relevance to the job market but it throws light on the compensation structure within hedge funds. While compensation of those holding operational roles remain largely independent of fund performance, those involved in the investment process often have strong financial incentives to find winning investment ideas.

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It is no secret on Wall Street that hedge fund returns haven’t been a source of excitement this year. In fact, hedge funds have struggled to post gains of only 4.6 percent to date, despite the S&P 500’s meteoric climb past 15 percent in the same span of time. While many would expect hedge fund managers to be concerned about their performance, Kevin Roose of New York Magazine reported that the atmosphere at the fifth annual SALT hedge fund conference remains upbeat. That’s because, even with the considerable under-performance to date and over the past few years, the hedge fund industry continues to earn high fees as well as attract large sums of new investment capital. Why is this?

It comes down to institutional investors, particularly pension funds, that aim for regular, consistent absolute returns every year, something equities cannot provide alone due to market volatility. In the past, these investors could diversify their portfolio using bonds, but the current interest rate environment isn’t providing sufficient levels of returns in order for the funds to meet their hurdle rates. So pension fund managers are looking for alternative asset classes that have characteristics similar to bonds, but offer higher returns. Some private equity strategies offer these types of returns, but more commonly, hedge funds are viewed as the answer. Hedge funds that employ market neutral strategies in particular that offer consistent, albeit lower, returns over time have seen a lot of attention from struggling pension portfolio managers.

In exchange for offering more management intensive strategies, hedge funds generally charge fees substantially higher than what one would see in an actively managed equity fund. Typically, this is done as a 2 percent fee upfront for assets under management and 20 percent cut of any profits the fund earns. While some would anticipate fees would come under pressure due to the low levels of returns, the industry isn’t really seeing any decline in their revenues.

“I keep waiting for fees to go down, but they’re only going up,” Jan Buchan, a hedge fund industry veteran, told Roose at the conference.

This view is consistent with the results observed amongst leading funds. For example, John Paulson, who has lost $9.4 billion over the past two years for his clients, is still charging his regular fees. In fact, he’s still attracting investors. As an overall industry, hedge funds took in $817 million in new investor capital in April 2013 alone. There certainly isn’t a great deal of pressure on this group of fund managers, despite less than stellar returns.

What are the Implications for Hedge Fund Job Seekers?

As a result of stable fees, hedge funds have been able to offer more stable opportunities than their financial industry peers in investment banking or asset management. While there has been some pressure on the regulatory front that has increased expenses, along with jurisdictional questions for some funds, hedge fund employees have largely been able to rely on their employment more than their peers. This should continue into the foreseeable future, as long as interest rates remain low and hedge funds are positioned as one of the most attractive alternatives to the fixed income asset class.

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