A Delicate Art For a hedge fund, getting compensation right can be the difference between success and failure. For our inaugural Hedge Fund Compensation Report, we surveyed more than 800 people at nearly 600 firms to find out what they are paid — and what they think of their money. By Imogen Rose-Smith

Compensation is at the very core of the hedge fund industry. The opportunity to earn vast sums of money has long drawn people from traditional asset management firms and investment banks. With a little luck and a lot of savvy, analysts and traders can dream of winning their places on our list of top 25 earners in the business. The minimum required this year: $240 million.

But the question of compensation is not just about the number of zeros on a paycheck. It is also about how firms manage their businesses and investment risks. Although there is no easy answer for how best to structure compensation — different firms favor different models — getting it wrong is a sure route to disaster.

“Half of the hedge funds that fail do so for non-performance-related reasons, including compensation,” says Michael Hennessy, a co-founder and managing director of institutional investment adviser Morgan Creek Capital Management in Chapel Hill, North Carolina. “At far too many funds, the top guys are getting disproportionately rich, and that leads to a lot of turnover, which can hurt investors.”

Hedge funds are as secretive about the details of their compensation structures as they are about their investment strategies. In an effort to tear through the veil, Alpha magazine decided to conduct our first poll of compensation practices in the hedge fund industry. Beginning in late January, we surveyed more than 800 employees at nearly 600 firms in 30 countries. Professionals at hedge funds of all sizes and strategies participated in the survey — everyone from junior marketing associates to CEOs. People at many of the industry’s very top firms took part in the survey, including participants from two thirds of Alpha’s 2006 Hedge Fund 100 ranking of the world’s biggest single-manager firms.

Senior executives at top hedge fund managers are getting very rich indeed. The median pay for a hedge fund CEO is $1.3 million, according to the Alpha survey (the average is $4.9 million). Apart from the CEOs, senior investment professionals, especially chief investment officers and portfolio managers, are receiving the bulk of the wealth. One senior portfolio manager at a large hedge fund specializing in emerging markets earned $13.3 million last year. The top-paid CIO came in at $22 million. But some noninvestment professionals are doing well too; at many firms pay for a risk management officer is second only to that of the most senior investment official.

What is rarely discussed, however, is how much executives’ compensation can vary from firm to firm. One CEO, for example, who runs a small long-short equity fund with $1 billion in assets, reported to us that he made just $100,000 last year.

The Alpha Hedge Fund Compensation Report upends much of the conventional wisdom about hedge funds. Our data show that the $100,000 CEO is not alone; most people in the hedge fund industry are not taking home seven-figure annual paychecks. The findings also indicate that life at a small hedge fund can be an especially long slog, with relatively little financial reward. Even junior traders at bigger firms would often be better compensated working at an investment bank.