A Delicate Art By Imogen Rose-Smith

The popular assumption that hedge funds pay better than investment banks is not always true. Eric Moskowitz, a director with New York–based recruiting firm Options Group, says that banks often pay more than hedge funds, especially for junior traders and analysts.

“If you are not at a top 20 hedge fund, then the truth is that you are probably going to be better paid at a bank,” says Moskowitz. A third- or fourth-year associate at an investment bank — the equivalent to a junior analyst or junior trader at a hedge fund — typically earns a combined base salary and bonus of $225,000 to $300,000, according to the Option Group’s research. In the Alpha survey, a junior analyst with four years or fewer of hedge fund experience makes an average of $297,000; a junior trader earns $226,000.

Proprietary traders at an investment bank can in many cases also earn more than they might make at a hedge fund. The very-best-paid traders responding to Alpha’s hedge fund survey make $1.6 million to $4 million. A senior exotic, or complex, derivatives trader at a bank in New York can earn as much as $3 million, according to data from London-based executive recruiting firm Napier Scott Executive Search. Top traders at investment bank Goldman, Sachs & Co. make $20 million to $50 million a year.

Being an investment professional at a hedge fund is almost always more lucrative than working at a traditional asset manager. According to a 2005 survey conducted by the CFA Institute and investment recruiting firm Russell Reynolds Associates in New York, the average compensation for an executive with ten or more years of experience at a traditional investment management firm is $240,000. That’s on par with the average base salary of the senior portfolio manager with at least 11 years at a hedge fund. But the latter’s $1.4 million average bonus is more than 20 times the $64,000 bonus made by the investment professional in the traditional asset management world.

Like many aspects of the hedge fund business, compensation practices can be traced back to Alfred Winslow Jones, the sociologist and former journalist who is generally credited with inventing the modern hedge fund. When Jones launched his firm, A.W. Jones & Co., in 1949, his genius was not so much in adding short selling to investment management as in the way he structured the fees. Historically, asset management had been a low-margin, relatively low-revenue business, which held out the promise of a steady income stream but not much else. A few years after launching his fund, Jones began charging investors an incentive fee of 20 percent of profits. (Unlike most of today’s hedge fund managers, Jones did not charge an asset-based management fee.) The performance fee, also known as the carry, was shared by the fund’s partners. Suddenly, the amount of money that could be made skyrocketed.

It is impossible to overestimate the impact of Jones’s fee structure. Today top-performing firms such as James Simons’ $26 billion Renaissance Technologies Corp. command performance fees far higher than the 20 percent Jones charged. Renaissance’s $6 billion Medallion fund charges a 5 percent management fee and a 44 percent performance fee.

Parceling out the riches generated by these fees has become increasingly complex as hedge funds have grown in size and number and the market for talent has become more competitive. “If you don’t share, you are taking a huge risk because people are going to leave,” says John Casey, co-founder and chairman of Casey, Quirk & Associates, an investment management consulting firm in Darien, Connecticut.

Bonuses are the principal means by which hedge funds share the wealth. Managers generally follow one of two models: a trading-oriented system that links pay directly to the investment returns of the assets being managed; or a more discretionary program, often used with analysts, whereby bonuses are determined by the partners and senior management.