Bonuses, which are cash and other financial incentives commonly provided to finance professionals, are part of the culture at hedge funds. The typical bonus size is between 15 percent and 25 percent of the profits a hedge fund manager is responsible for producing at the firm. Bonuses are a year-end phenomenon, as they reflect the work a trader has done in the most recent 12-month period. Financial firms on Wall Street -- including hedge funds -- typically pay year-end rewards during a bonus season, which generally starts at the end of December and can last until February.
The precise time at which a hedge fund trader is informed that he's entitled to a bonus and the day he actually receives the check aren't always the same. It isn't unusual for executives to share the news with hedge fund traders who qualify for a bonus weeks or months before any checks have been signed due to administrative or other logistical reasons. This can prevent a fund trader from feeling unappreciated and disgruntled or even leave for a competitor in the days or weeks leading up to the time the bonus is actually paid.
Hedge funds are known for their lofty fee structures. The typical fee structure has two components, including a management expense that can be as high as 2 percent of a client's total investment. Hedge funds are entitled to keep as much as 20 percent of all profits each year. Hedge fund trader bonuses are typically paid from the performance component of the fee structure.
Performance and Bonus
The size of a hedge fund trader's bonus check is directly linked to the profitability of the hedge fund firm. In 2012, the average hedge fund had returns of about 6 percent, which wasn't as good as the broader stock market but exceeded performance in the previous year, when most hedge funds lost money. The average trader's compensation increased by 15 percent in the year, which was largely due to rising bonuses, according to a 2013 FIN Alternatives report. Base salaries rose a mere 4 percent in 2012 versus more than a 30 percent rise in year-end bonuses. While the average hedge fund investor earned more than $300,000 that year, more than half of that was attributed to bonuses -- at least at the most successful hedge funds.
Hedge Funds vs. Investment Banks
Following the financial crisis of 2008, new rules were established on Wall Street that affected compensation for finance professionals. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, employees of investment banks -- including those running hedge funds within these institutions -- were faced with a cap on the size of year-end bonuses. Independent hedge funds that aren't part of a larger bank aren't subject to those same limitations. This caused financial traders to defect from their employers to work at independent hedge funds. In doing so, not only could traders earn higher salaries, but they could receive more than half of their year-end bonuses in cash, according to a 2012 article on the Bloomberg website. The remainder of the payout is usually invested in the hedge funds managed by the firm.
- Pensions and Investments: Hedge Funds Gain 6 Percent-7 Percent in 2012, but Trail Stock Market Indexes
- The New York Times: The Invisible Hand Behind Bonuses on Wall Street
- Bloomberg: SAC Capital Said to Raise Bonuses Amid U.S. Insider Probe
- New York Society of Security Analysts: If the Bonus Season Made a Fashion Statement, Color It Gray
- Bloomberg: Billion-Dollar Traders Quit Wall Street for Hedge Funds
- Towers Watson: Hedge Fund Investing -- Opportunities and Challenges
- Barclay Hedge: Hedge Fund Salaries -- What Is The Average Salary of a Hedge Fund Manager?
- Financial Times: Hedge Fund Bonuses Signal Rosier Times
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.