The hedge fund managers who make the most money every year, do it mainly from having their own money in the fund, and having the fund do well. So why they make so much money is that they are rich to start the year and skillful investors. Of course, hedge fund managers also make money from the profits of their business.
Hedge funds usually charge a performance fee, which is an entirely different business model. They make money by generating a better return on the assets they have. In fact, to the extent the hedge fund strategy has capacity constraints, the managers would like as few outside assets under management as possible.
American executives argue—conveniently enough—that their compensation should be compared to what other American executives are paid. This argument has tended to be persuasive to American boards, which—conveniently enough—are made up primarily of American corporate executives.
CEOs of U.K., Canadian, and other Anglophone firms tend to earn at close to American levels. These kind of local differences matter so much because, as Ray Fisman has explained for Slate, executive compensation decisions are typically made by peer group comparisons.
These days, though, institutional investors, such as pension funds, charitable endowments, and even government investment funds, are big investors in hedge funds. To some extent, at least, the hedgies, with their exorbitant fees, are pocketing money that could be going to teachers, firefighters, and ordinary taxpayers.
One of Paulson’s funds gained more than sixty per cent, but the firm also runs funds that didn’t do as well. Those were the top performers. In many other cases, hedge-fund managers were paid hundreds of millions of dollars even as they failed to beat the market by a considerable margin.
Because of their hefty management fees and the fact that they have billions of dollars of investments under management, some hedgies can make handsome returns even when they are generating what is known in the industry as “negative alpha.”.
That helps to explain the rise of index funds and exchange-traded funds, which are much cheaper than actively managed mutual funds. (Index funds purchase all the stocks in a given index. Actively managed funds try to beat the market by selecting various individual stocks.)