Hedge funds cultivated mercenaries. Now they want loyalty

Puerto Rico’s Dorado Beach, known for its luxury resorts and stunning scenery, isn’t an obvious choice for a hedge fund hub. But when a prized portfolio manager from Millennium, Izzy Englander’s $79 billion hedge fund behemoth, requested a relocation there a few years ago to take advantage of Puerto Rico‘s generous tax incentives, the firm was happy to oblige.

A similar request by a portfolio manager at Point72 to be transferred to Milan, Italy, another tax haven, also got an enthusiastic response. Point72, Steve Cohen’s $41.5 billion fund, arranged for the PM to work out of a WeWork and, according to the most recent regulatory filings, the satellite office now includes six people working in investing roles.

Several years in, the talent war raging among the world’s biggest hedge funds has reached a fever pitch — and employees are the beneficiaries.

A hiring crunch has raised the bar for what firms are willing to pay to lure top talent from rival firms. Firms are dangling pay packages in the tens of millions — in one case, $100 million — to keep top performers, or poach competitors’ talent.

Top talent can set their own terms in a way that would have been unheard of even a decade ago. In addition to moving to tax havens and off-the-beaten-path locales — Millennium has more than 140 offices, including Durham, North Carolina, and Boulder, Colorado — PMs have been known to invent new titles for themselves or demand to be the one to ask the first question at meetings with corporate CEOs.

This leverage extends down the ranks. Funds, once known for their cutthroat approach to cutting underperformers, have become more willing to overlook a bad quarter or two by money-losing PMs, allowing them time to recover their losses rather than immediately showing them the door.

It’s not uncommon for a portfolio manager to work for two or three of the top funds over a five-year span, including breaks to avoid violating non-compete clauses in their contracts. A PM who gets fired on a Tuesday often has an inbox full of suitors by Wednesday, and some PMs are even getting re-hired by firms that once pink-slipped them for losing money.

“Historically, capital was the bottleneck,” says one investor in several big-name hedge funds, who asked to remain anonymous in order to speak candidly. “Now it’s 100% talent.”

Founders, meanwhile, are increasingly finding themselves on the back foot. They’re complaining privately — and in rare cases, publicly — that their hired guns, who they trained over decades to be mercenaries, are behaving like mercenaries.

Inside Business is today’s must-read story on what the forces shaping business, tech, and innovation mean for you. Each piece delivers insights to help you make smarter career, money, and life decisions.

When a longtime PM from Citadel decamped earlier this year for Balyasny after he had lost money, the Miami-based firm told Bloomberg it was “extremely disappointed” the trader didn’t stay and try to recoup his losses. The statement was unusually frank and a window into the frustration funds are feeling.

As Fortune 500 CEOs, from Amazon’s Andy Jassy to AT&T’s John Stankey, reorient corporate culture around performance and the bottom line over soft skills and intangible values, hedge funds — suddenly desperate to hold onto talent — are taking the opposite approach.

Once content to “trade people like securities,” as one industry recruiter described it, the billionaires in charge are now looking for something beyond returns from their cadre of traders. They’re asking for loyalty.

The $5 trillion hedge fund industry has long operated with an eat-what-you-kill mentality. Bring in a lot of money, and you and the fund will do well; you might even get poached by a rival. Bring in less, and there are plenty of hungry investors to take their place. Hedge funds are “skill factories,” as a Goldman Sachs executive once put it, and people are replaceable widgets in an investing machine.

That ethos, combined with tight risk management and borrowed money from banks to boost performance numbers, is a hallmark of so-called multistrategy funds, trading behemoths that have come to define the industry. The segment is valued at more than $425 billion, according to Goldman Sachs’ recent estimate, with roughly half concentrated in the so-called Big Four, which includes Millennium, Point72, Citadel, and Balyasny.

These funds are less about a single investing genius making bold calls and more about the machine that blends together portfolios of equities, bonds, currencies, commodities, and other assets to create a return stream that is uncorrelated with any one asset class.

In the post-pandemic era, they’ve become victims of their own success.

The high mark came in 2022, when the S&P 500 was down by nearly 20%, but many of these funds had banner years. That led to an avalanche of capital. Tens of billions of new assets have poured into multi-strategy funds from institutional investors, such as pension and sovereign wealth funds, eager for steady returns.

More business demands a larger workforce. Millennium, the largest fund, has doubled its head count since the pandemic, to more than 6,000 people, according to regulatory filings, while Citadel, Balyasny, and Point72 have each added more than 1,000 people.

It’s a simple math problem, says one executive at a smaller multi-strategy firm that competes with the Big Four. Churn — both from pink-slipped underperformers and aggressive poaching from rivals — is a feature of these funds. Last year, the annual rate of PM churn was roughly 20%, according to alternative data provider Revelio Labs.

That means the biggest platforms need to hire dozens of new PMs every year just to maintain the status quo. Add in smaller players and new multistrategy players quickly staffing up like Jain Global, Capula, and Fortress, and that’s hundreds of new bodies needed each year.

Millennium alone hired around 160 new portfolio managers last year — an average of three a week — according to a person close to the firm. That’s equivalent to the entire workforce of $50 billion Tiger Global, according to regulatory filings.

“Does the universe create that many people who you haven’t already seen every year?” says an executive whose firm competes with the Big Four.

The fuel for these hugely lucrative machines is people, and there’s an energy crisis. The constant changing of nameplates at the cubicles is becoming unsustainable.

“It’s more competitive than ever,” says John Pierson, founder of P2 Investments, a recruiting firm that works with some of the industry’s biggest funds, adding that he’s noticed firms getting more creative in what they’re willing to offer. “The compensation is the smallest piece. The other things are really where they’re trying to outdo their rivals.”

“Loyalty is always worthwhile to chase,” Pierson adds. “Is it efficient? I think it is.”

At a 2023 event with fellow hedge-fund billionaire Paul Tudor Jones, Englander said that long non-compete agreements had helped create a “talent bubble” and an artificially small pool of potential hires that can demand more, according to a source who was in attendance for the talk. As Business Insider has previously reported, some of these contracts bar employees from working in the industry for years.

As if to prove his point, earlier this year, Englander put together an eye-popping $100 million pay package to poach Steve Schurr, who’d been a top stock-picker at Balyasny.

As one fund executive says, spectacular hedge fund payouts have gotten to the point “where numbers don’t mean anything.”

As part of a hiring spree last year, Balyasny used a package that could reach nearly $80 million to poach Peter Goodwin from Point72 to build a new stock-trading unit, three industry professionals tracking PM moves told Business Insider at the time. In January, Point72 poached Kevin Liu from Marshall Wace with an offer worth at least $50 million, Bloomberg reported.

These guaranteed payouts are possible due to the widespread use of “pass-through” fees, which allow hedge funds to pass off expenses related to hiring to their clients. This structure has led to a blank-check mentality, longtime industry players say.

The guarantees have irked end investors, several fund executives say, but managers are getting around this in creative ways. Instead of guaranteeing a $10 million payout, some funds are letting PMs keep 100% of the first $10 million in trading gains — essentially the same end result but without the risk of a headache-inducing headline for the investor relations team, an executive said.

The pressure to hand out spectacular paydays and bend over backward for talent has made the industry top-heavy to the point where second-tier funds need to constantly grow their asset base just to survive. At the end of September, smaller firm Eisler Capital announced it was closing because “the challenge of attracting and retaining experienced money managers capable of deploying capital at scale within a cost structure acceptable to investors has grown significantly,” a letter to investors reads.

The ripple effects of the talent war extend beyond the deals PMs are able to negotiate for themselves.

It’s pushed firms to build out legions of business development pros — essentially recruiters who work internally at these multi-strategy firms — who have also become coveted hires in their own right.

Balyasny spends roughly 1% of its assets each year on recruiting, the firm has said, which would put this year’s tally at $280 million, roughly the same amount an NFL team pays its players in a year. Citadel charged its investors a combined $8.6 billion across 2022 and 2023 for employee compensation and benefits, according to a bond prospectus seen by Bloomberg.

It’s made the vetting process of potential hires akin to spycraft due to confidentiality requirements around performance numbers. And it’s forced a streamlining of the recruiting process in some shops. At fast-growing Qube, a $34 billion quant fund, the manager recently capped the number of hours a single recruit can be interviewed for, at five, a person close to the London-based firm said.

To Citadel’s Griffin, the overall growth of assets in the industry has contributed to the demand for increasingly larger guarantees from talent.

“The biggest sea change has been the migration of the industry away from a more hard-nosed, driven focus on the performance fee to a much stronger focus on an asset-gathering business model. And that’s changing the nature of how people think about compensation,” Griffin said at last month’s closed Robin Hood conference in New York, according to someone at the event who heard his talk.

“We live in a capital society,” he said. “And wherever the scarce resource is in a profitable value chain, that’s where the money flows.”

Anecdotally, funds seem to be softening their cutthroat ways if it means they can retain PMs, even those who have lost money and would have once been cut without a second thought.

It’s hard to quantify whether there has been a wholehearted shift to a more tolerant structure, but four different fund executives say big managers have been slower to fire one-time top performers on a losing streak than they were five years ago.

With such a tight labor market, PMs who are let go can often find a new seat quickly.

While these PMs generally make a base salary in the mid-six figures, the big draw is the trading profits they’re able to keep for themselves. PM’s cuts can range between 15% and more than 30% of gains, but if a PM loses money, there’s no bonus until they’re back in the black.

At a new firm, though, the slate gets wiped clean — and the PM’s former fund and its investors are left with the losses.

For example, if a PM running a $1 billion book gets 20% of their gains in a year, a 10% return would net them $20 million. Often, they have to pay the analysts on their team a bonus out of this lump sum, but a solid year managing a sizable portfolio will result in a serious payday.

But if that same PM started the year by losing 5% — a drop that likely would have resulted in their firing before the talent war — then they don’t earn a cent until they’re flat again on the year. The fund next door, however, would let them start accumulating a bonus right away.

It might feel cutthroat to leave your employer with the check, but this is the result of the environment created by the same funds now complaining PMs don’t want to stick around. Some PMs even hire an agent now to get the best deal possible.

Much like private equity 15 years ago, multstrategy funds have reached a maturation point, and the shift has necessitated a more traditional workplace culture and structure.

Citadel, Point72, and Balyasny have all built training programs for college students and fresh graduates in hopes of creating an internal talent pipeline that fuels a sense of connection to the fund that gave them their first job. Partnership stakes in the business and longer-term financial incentives are becoming more common.

Balyasny, for example, added three new partners last year, all of whom are PMs. Point72’s Academy program, launched a decade ago, has produced more than 200 analysts. One executive at a smaller platform said his firm has discussed a large bonus pool structure that is tied to an individual’s profits generated over a number of years as a means of retention. In this example, a PM might get an extra, say, 2% of the gains they make in their portfolio after they’ve generated $100 million in profits for the firm overall.

“We have to make it so PMs don’t feel like they’re free agents all the time,” this executive said.

For Man Group’s Jay Rajamony, the director of alternatives for the firm’s Numeric quant unit, a key to retention and motivation is passion — people have to be excited to come to work, and firms have to reward people who take risks even if they don’t work out.

“Outcomes can’t be controlled, but we can control the process,” he said in an interview at the firm’s London headquarters.

“The most street cred should go to the person who is the most creative or bold.”

But shifting to a more subjective management style focused on soft skills will not come easy for founders or PMs.

“You set up something to attract mercenaries but now want loyal soldiers,” says one person who invests in hedge funds for a large pension fund. “It doesn’t work.”

Bradley Saacks is a correspondent at Business Insider. He covers hedge funds and other asset managers.

Read the original article on Business Insider