Let’s be honest, a lot of people (maybe the vast majority) get into finance to get rich. And there’s no better way to get rich than getting into a hedge fund, right?
With several hedge fund principals earning billions in a single year, and many of their workers getting millions and tens of millions in bonuses, the hedge fund career seems like THE best way to make a lot of cash in the finance game. But, like any profession, looking at the top gives one a skewed viewpoint.
Many hedge funds are quite small—the ones managing less than $100 million outnumber the ones managing billions, and simple math tells you those smaller funds aren’t minting dozens of millionaires. Assuming a 1.4% management fee (the average for hedge funds at the end of 2020, according to Hedge Fund Research, Inc.), a $100 million fund is getting gross revenue of $1,400,000 per year, excluding any possible performance fees. But running a hedge fund isn’t free—or cheap. About 69% of revenue will be swallowed up by costs the hedge fund must bear for administration, lawyers, auditors, rent, etc. (that’s the average according to a study by Meketa Investment Group), so that $100m fund is really worth just $434,000 to the hedge fund manager. In all fairness, that’s a good living, and a hedge fund manager who works alone and keeps that $100 million in assets can have a nice upper class lifestyle—but we’re far from the riches many associate with the hedge fund life.
Still, there is room for growth, and a good investor who can grow that small hedge fund to a big one can earn a lot—but the start-from-scratch hedge fund model is not typical for people in this industry.
Here’s a more typical career progression: a university student at a so-called “target” school (yes, sadly, this still means the Ivy Leagues for most in the finance world, which still has a lot of work to do to address equality and social justice) will get a job at an investment bank as an analyst. The IB analyst does not have fun; 80 hour workweeks are the norm, with even longer hours not uncommon. A lot of this work is very basic—fixing spreadsheets and presentations, fielding emails, and so on. The idea in the industry is that the analyst is learning on the job, and after two years of this lifestyle will have the skills needed to graduate to a role with more responsibility, whether in research, sales and trading, deal-making, or some other high profile job.
This is the point where some, but certainly not all, in the industry make the jump to hedge funds.
At this point the fresh-out-of IB will feel relief that hedge fund jobs have saner hours, with 60 hour weeks more the norm and some offering even better conditions. Pay will increase significantly as well, most likely doubling from the ~$100,000 to $160,000 range junior analysts at investment banks earn. Pay will also increase over the next few years—if the analyst does well. If not, they will most likely be fired.
A few years later, the analyst might get a promotion or be poached by a rival firm and start earning over a million dollars a year, in the form of a large bonus and salary. More performance and more promotions, with the possibility of a particularly skillful analyst (now usually given the title of “associate” or “director”) being given his or her own fund to manage. This is where those $100 million funds discussed above most typically come from, and the new fund manager will then work aggressively to grow the fund both by marketing her fund and by doing very well in the market. Both will attract more investors.
A few years of that, and a fund can grow to be even larger, and the compensation the fund manager earns will rise as a result. But the manager could also do poorly—one bad year has been enough to cause investors to pull funds from small hedge funds and for the manager to suddenly be out of a job. This is very common.
In short, hedge fund careers can result in significant wealth, but there are tremendous risks along the way at each step. This is why just a small fraction of IB analysts go for a hedge fund job after their two year purgatory, with many others seeking alternative paths that are less remunerative and less stressful.