Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in the rarefied realms of Wall Street.
One manager, John Paulson, last year earned $3.7 billion (Rs14,800 crore). He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them.
Paulson, founder of Paulson and Co., was not the only big winner. Two other hedge fund managers, James H. Simons and George Soros, each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor’s Alpha magazine, which was published on Wednesday.
George Soros made $2.9 billion in 2007 when his flagship Quantum fund returned almost 32%, according to data compiled by the Alpha magazine for its ranking of hedge fund managers
Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again.
Even on Wall Street, where money is the ultimate measure of success, the size of the winnings makes some uneasy. “There is nothing wrong with it—it’s not illegal,” said William H. Gross, the chief investment officer of the bond fund Pimco. “But it’s ugly.”
The richest hedge fund managers keep getting richer—fast. To make it into the top 25 of the list, the industry standard for hedge fund pay, a manager needed to earn at least $360 million last year, more than 18 times the amount in 2002. The median American family, by contrast, earned $60,500.
Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Simons and Soros, were also at the top of the list for 2006.
To compile its ranking, Alpha examined the funds’ returns and the fees that they charge investors, and then calculated the managers’ pay.
Top hedge fund managers made money in many ways last year, from investing in overseas stock markets to betting that prices of commodities such as oil, wheat and copper would rise. Some, like Paulson, profited handsomely from the turmoil in the mortgage market that has since ripped through the economy.
As early as 2005, Paulson began betting that complex mortgage investments known as collateralized debt obligations would decline in value. Then, over the next two years, he established two funds to focus on the credit markets. One of them returned 590% last year, and the other 353%, according to Alpha. By the end of 2007, Paulson sat atop $28 billion in assets, up from $6 billion 12 months earlier.
Soros, one of the world’s most successful speculators and richest men, leapt out of retirement last summer as the market turmoil spread—and he won big. He made $2.9 billion for the year, when his flagship Quantum fund returned almost 32%, according to Alpha. Simons, a mathematician and former US defence department code breaker who uses complex computer models to trade, earned $2.8 billion. His flagship Medallion fund returned 73%.
Like Paulson, Philip Falcone, who founded Harbinger Partners with $25 million in June 2001, placed a winning bet against the mortgage market. He pulled in returns of 117% after fees in 2007 and took home $1.7 billion.
Hedge fund managers share their success with their investors, which include wealthy individuals, pension funds and university endowments. They typically charge annual fees equal to 2% of their assets under management, and take a 20% cut of any profits; the 80% is for investors. With a combined $2 trillion under management, the hedge fund industry is coming off its richest year ever—a feat all the more remarkable, given the billions of dollars of losses suffered by major Wall Street banks.
In recent months, however, scores of hedge funds have quietly died or spectacularly imploded, wracked by bad investments, excess borrowing or leverage, and client redemptions—or a combination of them. As the list shows, managers who reap big gains one year can lose the next.
Edward Lampert of ESL Investments and a member of the 2007 Alpha list, was absent this year. His fund fell 27%, according to Alpha. About 60% of ESL’s equity portfolio is invested in Sears Holdings Corp., whose shares plunged 40%. ESL is also a major holder of Citigroup Inc., whose abysmal performance matched that of Sears.
A manager who ranked high in the 2007 list and fell off in 2008 was James Pallotta of the Tudor Investment Corp., who was 17th last year and took home $300 million. Pallotta’s $5.7 billion Raptor Global Fund fell almost 8% last year, according to Alpha, its first down year since 1994. Spokespersons for the hedge fund managers either declined to comment or could not be reached.
Since 1913, the US has witnessed only one other year of such unequal wealth distribution—1928, the year before the stock market crashed, according to Jared Bernstein, a senior fellow at the Economic Policy Institute in Washington. Such inequality is likely to impede an economic recovery, he said. “For a recovery to be robust and sustainable, you can’t just have consumer demand at Nordstrom,” he said. “You need it at the little shop on the corner, too.”
Despite the growth of the industry, it is relatively lightly regulated. The growing wealth of these funds and their managers may reignite the regulation debate. On Tuesday, two panels appointed by US treasury secretary Henry Paulson advised hedge funds to adopt guidelines to increase disclosure and risk management.
And Gross, the fund manager, warned that the widening divide among the richest and everyone else is cause for worry. “Like at the end of the Gilded Age and the Roaring Twenties, we are going the other way,” he said. ”We are clearly in a period of excess, and we have to swing back to the middle, or the centre cannot hold.”
©2008/THE NEW YORK TIMES