The Pathak Group at
MorganStanley
The Personal & Business Challenges of a
Hedge Fund Manager
A White Paper by Raju Pathak, Managing Director – Wealth Management
A number of factors including volatility in global markets, increased regulation, high-profile scandals, waning
appetites for risk and increasing client-demands for more transparency and detailed reporting have combined
into what some might consider a perfect storm for complicating life and day-to-day business for hedge
fund managers.
Managing a hedge fund has always been a demanding task at best, fraught with high-levels of stress and
uncertainty, and subject to a never-ending need to produce. After all, by definition a hedge fund is expected to
out-perform on a risk-adjusted basis.
In addition, the 2008/2009 bubble-burst, the steady increase in the number of hedge funds over the past several
decades, and the increased regulatory scrutiny have brought about an escalation in both organizational and
operational challenges within this high-pressure world.
Despite these challenges, the benefits of hedge fund management can be significant. The risk/reward
environment is certainly alluring, and the overall appeal of the endeavor cannot be argued, assuming, of course,
that the fund delivers.
Leaving the definitions and operational details aside, there are various plusses and minuses of both the personal
and business nature associated with managing a hedge fund. It is these specific issues that comprise the content
of this briefing. As you will see, there are common-threads relating to the individuals involved; industry trends
that impact both family and professional life, and structural issues that create unique challenges for the
managers themselves, ranging from managing their personal wealth to managing their careers.
The Personal Side – Common Complications
Based on research, personal experience, and dozens of interviews
and conversations, we’ve determined that today’s hedge fund
managers tend to be highly-competitive, high-achievers with
resilient personalities, a strong will to win and a seemingly
tireless work ethic.
Of course these positive attributes might also be described as
mere table-stakes when one considers the considerable
demands of the job.
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100%
80%
Life/Work
Balance
60%
Managing
Personal Wealth
40%
Career
Management
20%
Performance
Demand
0%
Key Personal Issues
Aside from various industry-specific and business related factors, which will be addressed in the second-half of
this summary, we found the key personal issues contributing to hedge fund managers’ above-average stress
levels fall into four primary categories:
•
•
•
•
“You must use the good
years to protect yourself
against the bad ones.”
High demand for performance
Career management
Personal wealth management
Work-life balance
As you are well aware, hedge funds are primarily privately-owned companies that pool investors' dollars and
reinvest them into select financial instruments. Their goal is to outperform the market on a risk-adjusted
basis—by a lot.
Given this definition, client expectations are high. The sheer number of funds has also increased over the past
several decades, as has the average fund size. Consequently, the challenges associated with delivering these
results have increased as well—by a lot.
So the pressure is on… and not only is a fund manager’s perceived level of success and income a function of
performance, but also his or her reputation and ability to get another job should something go wrong.
Furthermore, once a level of success is achieved, both sustainability and the fear of loss become increasingly
significant; and short of hanging-out a shingle and facing significant barriers to entry, moving forward
to a better position with a different fund is not often a possibility.
In addition, the right investment opportunities are not easily
identified and are often fleeting, so a hedge fund manager
puts in long-hours and never really checks-out. Making
investment decisions at the hedge-fund level requires a
unique combination of in-depth research and analysis, innovative thought, planning, timely-execution,
business acumen and, simply stated, presence.
“You never stop thinking
about the job…”
“You never stop thinking about it,” one manager said. “Not on weekends or even on vacation.”
As many more also pointed out, societal and family expectations are different today, as spouses of both
genders are expected to not only provide, but to also be involved. So, in addition to the performance-related
stress is the issue of balancing a heavy workload with the desire to live up to those expectations—to “be
present” for family, both physically and mentally.
Taking into consideration the tension and worry created by high-performance expectations, a long work week
and family needs, it’s not surprising that hedge fund managers must find ways to constantly manage and
minimize stress.
While some confessed they find it difficult to “slow down” due to personal work habits and personality makeup, most spoke of managing the tension through exercise, with a fair percentage involved in high-impact or
extreme sports, including marathons, triathlons, and aggressive fitness training.
Others admitted that they handled the stress by simply working harder. One manager commented, “You must
use the good years to protect yourself in the bad years.”
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Of course others reported instances of not handling
the strain as well, relating stories of divorce,
unwittingly “taking it out on the kids,” substance
abuse and, in some cases, damaged or lost careers as a
result of the 2008/2009 downturn.
“I worry about whether I’ll have
enough… about my kids, and if
they’ll be ok… if they’ll appreciate
wealth and work hard.”
Likewise, despite the fact that the average hedge fund manager’s compensation is at a level that most would
consider to be on the high-side of high-end, we detected a consistent and wide-spread angst among those we
spoke with relative to their personal finances and their financial futures.
Regardless of personal wealth or popular belief, albeit with some exception, a surprising number of today’s
hedge fund managers are conservative in nature, exhibiting relatively moderate spending habits and sharing
an underlying fear of someday not having enough to sustain their families.
“What keeps me up at night is the question of whether or not I have enough money to live on if something at
work changed… if something were to go wrong,” one middle-aged manager explained. “I worry about my kids,
and if they’ll be ok… if they’ll appreciate wealth and work hard.”
In fact, in spite of a familiarity with the world of investing that would theoretically qualify hedge fund
managers as the ultimate “do-it-yourselfers” for managing their own wealth, the above-referenced qualms
and time-related challenges have moved managers toward—more often than not—a perplexing
predisposition toward personal liquidity and less-than-sophisticated investment strategies. In other words, the
typical manager’s personal portfolio is cash-heavy.
Naturally, a potentially-large portion of a manager’s personal wealth is invested in their own fund and possibly
in other hedge funds as well. To be fair, restrictions on the types of personal investments hedge fund
managers are allowed to make are also a complication that promotes liquidity or, at the very least, a reliance
on bond investments, real estate, or fine art, the markets for which are quite different than the markets in
which hedge fund managers are most experienced.
One might then conclude that an obvious solution for hedge fund
managers is to develop a professional relationship with a personal
financial advisor. Many managers acknowledged that there are
advantages to this approach including access to select investments
that otherwise could not be accessed, the incorporation of
portfolio diversification, convenience, objectivity, strategies to
minimize or reduce taxes, estate planning, and even assistance
with philanthropic strategies, as hedge fund managers are frequently approached for their monetary support
for different causes. “It can be very helpful to have a qualified charitable-giving coordinator to manage and
prioritize the many requests,” one manager explained. “You can’t say yes to everyone, but it can sometimes
be difficult to say no.”
“I can’t imagine anyone
being more qualified to
manage my money
than me, but…”
Other managers highlighted how a financial advisor could provide access to desirable “concierge” services
such as educating their children about money or planning family vacations. Ultimately, a financial advisor
could provide the confidence associated with having a personal and capable sounding board, or a singlesource for coordinating all aspects of their wealth – a “CFO/portfolio manager of their lives.”
Or as one manager phrased it, “A financial advisor’s role for most managers will involve keeping them rich
versus making them rich.”
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But the paradoxical relationship between fund managers’ investment-related knowledge and the above-noted
anxieties and tendencies toward self-reliance instead tends to encourage a more apathetic approach. So, like
the proverbial cobbler’s children, today’s hedge fund manager is most likely putting a great deal of personal
effort and focus on managing the fund, and has little time to switch gears toward managing
personal wealth in a comprehensive or diversified fashion.
“Truthfully, I can’t imagine anyone being more qualified to manage my money than me,” said a successful
industry veteran. “But you have to put in a lot of time to be successful… so it’s hard to find time to think
about personal investments.”
The Business Side
Alfred Winslow Jones launched the first hedge fund in 1949 and set forth to try to minimize the risk in holding
long-term stock positions by short selling other stocks. When coupled with the use of leverage, Jones’
approach for achieving enhanced returns was innovative and quite successful. Within three years he altered
the structure of his investment vehicle, converting it from a general partnership to a limited partnership and
adding a 20% incentive fee as compensation for the managing partner.
But as is the case with most maturing industries, much has changed in the hedge fund sector over the past
several decades. By the late 1960’s there were over 140 hedge funds in the U.S. and, despite many failures
during bear markets and the 2008/2009 down-slide, the number of funds has soared to over 15,000 today
according to Prequin, a leading alternative assets industry source of data. 16000
14000
The sheer number of funds has not only increased competition, but
has also decreased opportunities for differentiation. As one manager
said, “So many funds are using similar strategies and methods that
the less established funds must fight harder to acquire new
business as well as to retain their clients.”
12000
10000
8000
6000
# U.S. hedge
funds
4000
2000
0
Numerous industry scandals, such as the infamous Bernard Madoff fraud
1965 1995 2005 2014
and the Galleon Group insider-trading affair, along with increased regulation
in recent years have also complicated the operational side of managing a hedge fund. Auditors are demanding
more transparency, and more in-depth and regular reporting. At the same time, more funds are now
registering with the Securities and Exchange Commission (SEC) adding to the need for staffing accounting and
clerical personnel to comply with related filings and reporting requirements.
“A good portfolio management
team used to be enough, but
now you also need a good
business team.”
Due to these complexities, managers are now finding
that they need to be both astute business managers
as well as astute investors.
As one fund manager explained, “A good portfolio
management team used to be enough, but now you
also need a good business team. More in-depth compliance demands and stiff penalties for regulatory
mistakes have increased both the cost-of-doing-business and the barriers-to-entry.”
Investors have become much savvier over the years and their expectations have grown in proportion. As a
result, many managers are finding they must hire both marketing and investor-relations professionals to
handle the increased demand for greater transparency, more frequent meetings and performance
updates, and more responsive client service.
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Not surprisingly, this increasing sophistication on the client side along with the proliferation of hedge funds
and market efficiencies has also put pressure on fees. The 20% incentive instituted by Alfred Winslow Jones
back in the nineteen-fifties, which widely prevailed until the past five or ten years, is now often 15% or less,
and the 2% fee that prevailed for many years has, in many cases, worked-its-way down to 1%.
So generally speaking, costs have escalated while compensation has declined.
Further complicating matters is a mounting reluctance on the part of investors to accept the longer
investment terms or “lock-ups” that only a few years ago were quite the norm. In other words, clients are
now demanding the ability to withdraw their cash on shorter notice, as they are less willing to sacrifice relative
liquidity for the expectation of better results – today they expect both!
“Two or even three year lock-ups were common,” one
manager said. “Now it’s much shorter.”
“The ramifications of poor choices
are much greater today... which
can be bad for clients.”
The combined effect of escalating investor
expectations, increased regulation, and declining fees
has brought-about an interesting paradox. Clearly investor-demand for hedge fund performance is very
strong; but the above-referenced mix of factors has put significant pressure on fund managers to not only
perform but to also avoid mistakes – which has, as a number of managers explained, promoted a reluctance
toward risk-taking that can sometimes make it more difficult to achieve higher returns.
“The ramifications of poor choices are much greater today,” one manager noted. “Regulation has ramped-up,
compliance departments are more extensive and any regulatory mistake will result in a lot more trouble…
which can be bad for clients because managers need to spend more time dealing with compliance issues
rather than managing money, and are less willing to take risks
Common Hedge Fund-Selection Criteria¹
that could lead to higher returns.”
Investment objective: What are you
trying to achieve with this investment? Is it
lower volatility, enhanced return, or less
correlation to other investments?
Structure: Are you looking to select a
single manager / strategy fund to build out
your own allocation to hedge funds or are
you looking to select a fund of funds to
manage an allocation for you?
Team: What is the make-up of the
investment team in terms of diversity,
experience and history, and the culture of
the overall organization?
From a business perspective, fund size represents another
paradox of sorts. While the world’s leading hedge funds tend
to be large—it is often said that “bigger is better” and the “big
keep getting bigger”— it is also true that finding investment
opportunities that can make a meaningful impact on a larger
hedge fund’s performance is more difficult.
However, the advantages of a large fund are many.
Risk management: Is risk management
an independent function that provides
checks and balances to the investment
process?
The soaring costs-of-doing-business noted above are more
easily absorbed by a larger fund. Additionally, newer or smaller
funds often face challenges when it comes to attracting clients
or raising money, which has resulted in extremely high barriersto-entry.
Operations: Does the fund have a sound
operational infrastructure backed by
dedicated support groups (i.e. legal,
technology, due diligence) to allow the
investment team to focus solely on
investing?
Investors have traditionally selected a fund or manager based
on the manager’s track record as well, which introduces
another challenge for newer managers who have not yet
established a history.
1 - Blackrock
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However, just as industry-related obstacles have grown, so too have the evaluation criteria investors typically
use for choosing a manager. In today’s world these measures frequently include the elements of investment
objective, fund structure, team risk management methodology and operational structure, thus creating more
challenges for funds of all sizes.
Finally we have the issue of succession planning. Given that the explosive growth with respect to the number
of hedge funds has primarily taken place over the past twenty-or-so years, it stands to reason that many more
investors and middle-managers are now facing the question of succession.
“Investors tend to flee
when the top people
retire.”
Since a fund manager’s performance and track record are such
important issues, it’s understandable that clients should be
concerned about who will be taking the reins should the
founder or founders decide to retire or scale back.
However, our research indicates that retirement is not a goal for most managers. Some indicated that with
experience comes better performance, so stepping-aside doesn’t present itself as a good option. Others
simply stated that “retirement is not in my makeup.”
However, while successful or high-profile managers may not be planning to retire, many within their firms
wrestle with the fear of what might happen should the top performer or performers suddenly become
unable to work.
“Investors tend to flee when the top people retire,” said one
manager.
Some funds have taken a more proactive approach to
succession planning by beginning to “groom” middle managers.
This process typically starts with getting them involved in both
investment-decision-making as well client relationships early
and then, over time, having the lead manager step back a little
at a time.As shown in the summary chart to your right, hedge
fund managers enjoy a rewarding, fulfilling and often exciting
profession, but also face a unique combination of personal and
business-related challenges that only a certain few
are capable of managing.
Personal & Business Challenges of a
Hedge Fund Manager
Personal
Business
Performance demand
Career management
Personal wealth
management
Work-life balance
Managing stress
Regulation
Increased client savvy
Escalating operational
cost and declining fees
Proliferation of funds
Succession planning
Certainly there are many business factors and job positions within a hedge fund that contribute to its overall
success… or the lack there-of. But while every player may be integral, “hedge funds are a lot like a football
team,” suggests HedgeCo Networks, an industry data base management firm.
“The failure or success ultimately will be placed on the coach…or in this case, the Hedge Fund Manager.”
Raju Pathak is Managing Director, Wealth Advisor at Morgan Stanley’s Boston office. He oversees an advisory team and manages
over $850 million in assets for hedge fund managers, business owners, and high-net-worth families:
www.morganstanleyfa.com/pathakgroup — (617) 589-3373.
Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors or Private Wealth Advisors do not provide tax or legal
advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and
other legal matters. The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Wealth Management or its
affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or
sale of any security. Past performance is no guarantee of future results. Morgan Stanley Smith Barney LLC. Member SIPC. CRC # 986209
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