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Managers' Income Varies Widely over Time

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NEW YORK (–Total fee earnings as a percentage of assets under management by hedge funds ranged from a high of 9.8% in 1991 to a low of 1.9% in 2002, according to estimates by Alexander Ineichen of UBS AG.

For 2004, managers’ profitability was middle of the range, at 5.5%. That includes both single hedge fund and fund of funds revenues. As to be expected, the latter were more stable compared to the former, especially in the past five years.

Fund of funds fees lost ground from 1999 to 2000 but then resumed their steady upward trend, going from US$1.5 billion in 2001 to US$4.1 billion in 2004. Single hedge funds’ income is far rockier as well as larger, suffering a steep drop from 1999 but recovering to a stellar year in 2003 with US$53 billion in profits. There was some erosion in 2004.

Manager income is a function of several magnitudes. Fee rates are an obvious factor, but they don’t jump around from one year to the next. Rates have been gradually rising, at least in the top tier of funds, but that does not explain year-to-year gyrations.

The amount earned in performance fees depends on a combination of fund returns and assets, while the management fee is a function of assets alone. Hence investment returns account for fluctuations in managers’ rate of profit, while asset growth explains the long-term increase in the absolute amount of manager income.

Taking the industry as a whole, fees in dollar terms hit a low point in 1998, at US$7.9 billion, and after recovering in 1999 went down again in the early 2000s, the UBS study shows.

But 2003 saw a more than five-fold increase in total manager income, to US$56.7 billion. In 2004 it went down to US$44.8 billion–still substantially higher than any year except 2003. This growth parallels large capital inflows to the industry.

Sharpe Contest

Mr. Ineichen presents updated historical performance figures. In all strategies, percentage returns to investors in relation to volatility were lower from 1990 though January 2005, compared with earlier performance from 1990 to March 2000.

Similar deterioration happened in traditional asset benchmarks, as well, however, during the past five years. Bonds were the only exception.

Equity hedge and global macro, the two long-time workhorses among hedge fund strategies, come out the best in terms of historical returns relative to volatility.

Going into sector detail, the HFR energy index had the highest long-term returns, with 25.7% annually from the first quarter of 1990 through the first quarter of 2005. But because of its high volatility, energy’s Sharpe ratio is below several other sectors’.

Relative value arbitrage has the highest Sharpe ratio for this 15-year period, at 2.01. Distressed securities and fixed income are the runners up in the Sharpe contest.

Contact Bob Keane with questions or comments at: [email protected].