Hedge funds have had a lackluster year, and a decline in profits despite higher management fee income from assets under management is expected to squeeze bonuses for senior and mid-level investment professionals by more than a fifth.

The poor performance is also casting a shadow on 2019, with both growth and assets under management expected to decline at hedge funds.

Hedge funds industry breaches $2 trillion mark Total capital invested in the global hedge fund industry exceeded $2 trillion for the first time in its history, according to data released today by Hedge Fund Research, Inc. (HFR), the leading provider of hedge fund industry data. Photo: Reuters

Senior and mid-level investment professionals will see bonuses, which usually account for most of their income, decline “substantially, this  year” said Adam Zoia, founder and chief executive of CompIQ, a technology firm that uses artificial intelligence and machine learning to help large companies get their compensation correct.

Investors pulled an additional $6.68 billion from funds around the world, according to the November 2018 eVestment Hedge Fund Asset Flows report, marking the global hedge fund industry’s third consecutive month of outflows. Outflows year to date is at $14.77 billion. Through November, 59 percent of hedge fund managers reported outflows for the year.

“I'm pretty convinced that the AUM growth is not likely to continue next year”, said Zoia. “The reason is the industry did bad year this year. So if you're an investor, you're an LP, a limited partner, you're not going to be inclined to be throwing money at hedge funds next year.”

The funds are also expected to cut back on hiring senior investment professionals in 2019. “I predict they will not do much senior hiring next year because you do senior hiring when you are optimistic about how things are going, and you expect your assets to grow, and you're expanding your business.”

Zoia expects hiring for junior and back-office professionals to remain the same in 2019. “You do routine hiring -- meaning junior investment professionals, accountants, administrative, operations, HR, etc., almost under any market condition as you need it. That’s just normal, so that that kind of hiring will continue on all certainty.”

He said most hedge fund strategies this year have had a hard time making a return and the last couple weeks have not helped. “Indeed, most hedge funds have a negative return for the year or very small positive return,” he said. “Since the profit is down substantially, the income certainly for the more senior people on the investment side and senior back-office (people) such as chief operating officer is down,” he added.

Zoia said quantitative investing -- hedge funds that base their trading decisions on algorithmic or systematic strategies -- is a category where there's been success despite the current markets conditions. He expects these funds to perform better than the other funds.

“I think those kinds of funds that can perform in a way that does not appear to be correlated with the overall market, will be of interest to investors, and those funds will likely retain asset inflows will be my prediction for 2019. Firms that can perform even in a challenging market, those firms will attract assets,” he said.

BONUSES TO TAKE A HIT

Zoia said the bonus compensation is going to be significantly down at single-manager large hedge funds where people do not have separate formulaic portfolios. “It could be down as much as 20-30 percent for portfolio managers or more. It depends upon how badly the firm did.” He expects the bonuses to be down for mid-level professionals as well.

For junior investment professionals in larger firms, compensation will likely be flat. “They are usually pretty shielded from the market vicissitudes as are back-office professionals.”

“At these large firms, we expect compensation for the non-executive back-office to be flat to up 1 percent,” he said. “For people like chief operating officer, chief financial officer, who in any large funds tend to participate in both the up and down direction with the performance of the firm, their compensation will be down at least 10-15 percent or maybe more, depending on how badly the firm did.”

He said if the incentive fee was negative, bonuses could be down 15-20 percent. And if the incentive fee was slightly in the positive territory, bonuses would be down more like 10 percent.

Zoia said, in large and medium-sized firms, the margin fee is fixed regardless of performance and these firms can pay bonuses even in a bad year, but not as big as in a good year. “A smaller firm doesn't always have that luxury, so there's a little bit of a distinction about what happens between compensation for people at larger firms or the smaller firms,” he said.