How Analyst Compensation & Incentives Impact Hedge Fund Success with HF Reflections (Bonus Episode)

Interactive Transcript

spk_0 Welcome to Other People's Money.

spk_0 What you're about to hear is a special bonus episode featuring one of my most popular

spk_0 guests, the anonymous Fitntwit persona at HF Reflections.

spk_0 If you don't know who HF is or you haven't listened to our original episode from a few weeks ago,

spk_0 I recommend you go listen to that episode first.

spk_0 This is an excerpt from one of a few conversations I had with HF where we touch on a very important

spk_0 topic, compensation and incentives.

spk_0 How a hedge fund manager structures their team and aligns compensation with the outcomes

spk_0 they want can have a huge impact on how work gets done, especially on the investment team.

spk_0 I like to remind everyone that nothing we say here is investment advice or marketing

spk_0 for any funds managed by HF Reflections.

spk_0 Everything is meant to be informative about the fund management industry.

spk_0 With that out of the way, let's get into the interview.

spk_0 So I want to get into the different constructions that you can have for analysts as well as

spk_0 back office and how you can align that with the business that you're trying to build.

spk_0 Sure, so this is actually something I'm very passionate about and I'm going to take the back

spk_0 office first.

spk_0 I'm going to focus mostly on COL or head-up operations and then we'll talk about analysts

spk_0 separately.

spk_0 This is more specific to the way I thought about my business and the tenure of people that

spk_0 I had.

spk_0 So on the back office side, I was actually the first hire that I focused on making and

spk_0 in my case, I hired someone that was more of my age and I wanted someone to feel the

spk_0 up and down of the business as I would.

spk_0 So I wanted at least one person to basically be incentivized on points where at launch where

spk_0 you have things won't go really well and things didn't go well.

spk_0 They'd share in some of the pain of that with me.

spk_0 And it's so happened that the person that I found for that role was excited by that.

spk_0 And so there was kind of a point and a comp structure.

spk_0 And what we did is there's kind of a salary level and that salary level started pretty

spk_0 low but it would scale as asset scale of the business.

spk_0 And I think that created a nice alignment so that if things won't well, it'd be a really

spk_0 nice outcome for that person but they were taking a little bit of risk.

spk_0 And that's what people tend to do with analysts.

spk_0 I chose not to do it with analysts and some of that I did for a few different reasons.

spk_0 So I've seen this work different places a lot of different ways.

spk_0 My general bias was I'm hiring people with less experience.

spk_0 I can handle some volatility in my income but I don't want a 23, 24, 25 year old that's living in

spk_0 in a city with high cost of living to have to worry about whether or not they can afford rent.

spk_0 Or if they are going to have to live off my low base salary unless we have performance.

spk_0 And so I basically took on that volatility and said, you know what?

spk_0 Like I paid people competitive cash compensation with a relatively narrow bonus range kind of

spk_0 consistent with they make it a $500 million dollar to billion dollar funds.

spk_0 And I did that because I didn't want to be worried to give someone points.

spk_0 I think points are important and that's something that I think makes sense to do personally

spk_0 after a couple of years when you do the person well and you have also more visibility

spk_0 on your business because when you're a startup like having points in a startup at least

spk_0 the first year she doesn't matter if you can put.

spk_0 And so I kind of wanted them to have certainty around compensation.

spk_0 And they need to trust me that you know to the degree they put it in this way actually

spk_0 well one they're not taking much for discount and paying them I think at market.

spk_0 And then two if we do get to the point where this point is worth something that I was going

spk_0 to kind of appropriate that appropriately compensate them with the ability to kind of do

spk_0 well and on-capped way if funded well.

spk_0 And so that was kind of the high level thought process I had around compensation for the

spk_0 analyst and maybe the only other thing I'd add which I think is really important.

spk_0 I felt strongly about it.

spk_0 I was like on compensation like a few different guiding principles.

spk_0 I think I've written a thread of us at some point but like one just like do what you say

spk_0 you're going to do.

spk_0 So the thing that just pisses me off to no end and thankfully I didn't have this experience

spk_0 but a lot of people that did is you know if you have some formula for someone's compensation

spk_0 and they hit out the park and that formula says you'd pay the person a million to $2 million

spk_0 even though that person's age or experience level shouldn't necessitate a fraction of that.

spk_0 You'll go to the person at the end and say well I know your agreements said this but I

spk_0 mean I'm not actually going to pay you that right I mean we both agree that's kind of silly.

spk_0 You don't do that I mean you actually you say what you're going to do and so if there's

spk_0 points and the funds are 50 or 60 gross you and it says the person should make this and

spk_0 have so much higher number than you thought you'd have to pay do it and you do it gladly

spk_0 because ultimately you know as the founder of the business if you if the formula says you'd

spk_0 pay someone a lot of money you probably have done really well and the stupidest thing you

spk_0 possibly do is your team that helped contribute to that amazing performance that got you

spk_0 that big compensation like nickel and diamond them because there's some frequency of notion

spk_0 of how much someone should make of a certain I just think it's stupid and so that was kind

spk_0 of the broad compensation philosophy I think they have with the the analyst team and I think

spk_0 also just giving in some sense of progression as well so I think people it's like their numbers

spk_0 to go up over time and I think rather than kind of have wild swings and people's conversation

spk_0 or some of that obviously happens when there's points but I like the idea of kind of slow

spk_0 and steady progression with uncapped upside such that they're really good year everyone does

spk_0 really well but but not having it be so volatile that people get used to what they were

spk_0 paid last year and this is an industry where your products up 50 and it's down 10 10 is going

spk_0 to be very different compensation levels each for those years and so I think kind of taking

spk_0 more of the volatility on the investment manager and smoothing things out a little bit for the

spk_0 analyst especially when they're younger and then letting them share more volatility both

spk_0 up and down as they get older I think the right way to do it and that's kind of how I conceptually

spk_0 approach doing things at the new firm there are formulas that people use to measure contribution

spk_0 specifically analysts but also sometimes the back office how do you think about measuring

spk_0 people's contribution and performance on both sides well so back office you know depends like I

spk_0 think especially if there's a marketing role I've seen people marketing function to the operations

spk_0 people I've seen them do things you know based on assets raised and even from back office kind

spk_0 of what I want it wasn't you know we didn't have extreme goals on a young growth we certainly

spk_0 don't today I just wanted to make sure that I could spend as much time investing as I could and

spk_0 so I've kind of joked with our COO that the definition of of success in back office is basically

spk_0 nothing bad happening and it's kind of like a goalie for a hockey team right like except you

spk_0 don't even get to see the saves the saves if they happen should be kind of invisible I like and see

spk_0 them and so when there's by nature of nothing bad happen things have gone really well but measured

spk_0 anything's hard it's more of a equality assessment but I think the basic way I think about it is

spk_0 the less time I have to spend on operations with nothing going wrong means the COO back office is

spk_0 doing a really good job and I don't want to get too much into stuff there but I think it points

spk_0 as nice especially for the most senior personal operations team and then I think some concept of

spk_0 potentially sharing a portion of management's income all like a pre-building the species I kind

spk_0 of like because then you're incentivizing the COO to to care about kind of the management

spk_0 firm P&L in a way that thinks kind of helpful so you can mess around at the boys but it's

spk_0 I'd say to the operations side the other side this is probably one of my favorite topics so I think

spk_0 there are a few different ways to do this one way people do it is they were literally you know tag

spk_0 each analyst on a name based on what they worked on and they'll add up the P&L the other year

spk_0 or each analyst had and they'll use that number and they'll pay some portion of that or some

spk_0 portion of the incentive fee on that they'll just use that qualitatively to assess how much they

spk_0 should pay the team it's just based on you know this is our P&L this is what I perceive your

spk_0 responsible for that's what you get they're all full list of issues with that I personally don't like

spk_0 I call it maybe a couple one is it's just so subjective especially if you have younger people

spk_0 working for you the reality is like I involved in everything you know maybe in three years that

spk_0 might not be as much the case but trying to do any you know what someone's responsible for I think

spk_0 especially earlier careers just hard to I think increase really bad incentives if especially

spk_0 compensated PF compensated alpha that's better but becoming the MP&L the biggest ratio just

spk_0 you're just incentivized to people to pull on exposure which I think creates really bad incentives

spk_0 so that's one way to do it I've seen people do it they're pros and cons so that count their

spk_0 choice I just says if heard some people say you know if you're directly if you're compensated

spk_0 directly based on your P&L like they're just a very clear return on you spending more time and

spk_0 making more money for the farm so you know that's one perspective I think the one I've taken is

spk_0 closer to the other inspector which is one team on dream for lack of a better term you know everyone

spk_0 gets points there's a bonus pool but everyone gets point to some point there's a bonus pool that

spk_0 bonus pool is paid out there's kind of some range or set criteria of how many points each person gets

spk_0 maybe there's some flex to that I mean one way of her describe is you have kind of a base point

spk_0 level there's a bonus pool of points that's kind of jump all you know we do something something

spk_0 like that and then I think maybe the only other adder on top of that is I generally think

spk_0 earlier in the funds trajectory you know more points should the crew to be found out of the

spk_0 business and over time the share given to the investment team should increase pretty much every year

spk_0 until it maxes out at some point which you know I think based on industry data I've seen

spk_0 from primes I think is about 30% ends up being shared with the team I'm going for something more

spk_0 than that for a whole list of reasons but I kind of think that's kind of how I've seen people do it

spk_0 also gets really complicated as well because if you have a seed if if the founder has a lot of

spk_0 people do you pay people on you know just the extra off-eaping capital do you pay them if there's

spk_0 a seed you kind of ding them for the share and so I think we created the structure that just made

spk_0 it really simple which is just based on the whole P&L whether it's me or RLP's like people are paid

spk_0 on everything and we put it together for everyone in a very clear kind of excel sheet so they know

spk_0 the course or chart of the fund is this you're going to make this and then your points are this

spk_0 and they conflict the this as you expected to increase modestly over time so everyone's on the

spk_0 same page they kind of know where they're going to net out and I personally like that and it

spk_0 allows you to do instead of compensating people based on how they did you can compensate based on

spk_0 behaviors right so instead of someone 40 and all their great ideas that they find even if it's

spk_0 in a sector they don't have much experience and let's say someone else on the team the means look

spk_0 at the idea on the past or is probably better at researching those types of situations instead of

spk_0 that person hoarding it and then getting around to it when they have time they're incentivized to share

spk_0 and if the fund does better then they do better because the points are worth more and if I want to

spk_0 for example if someone you know does something let's say they we pass on something right there's

spk_0 no P&L generated I have this idea and on the analyst commits is me it is a terrible idea and they added

spk_0 a lot of what I think of one of my friends called my friends called for P&L but wasn't for this

spk_0 analyst kind of doing this analysis that maybe we realized as to make a huge mistake yeah we

spk_0 would have lost a lot of money that doesn't show up in P&L but I want to incentivize that I want

spk_0 someone to you know when they do good work that results in the firm making more money whether it's

spk_0 by making more money from their research people or if I dare idea or making more money from

spk_0 a boy in a mistake like on a company someone that's what comes the other year I don't want to look

spk_0 at the P&L and say this is you know what you did this is what you paid I want it to be able to

spk_0 incentivize the behaviors that I want I think doing it on a team basis and leaving it more flexible

spk_0 and not actually so we can measure analyst P&L they don't at some point in the future I might but

spk_0 I just want to be judging the analyst based on process non-anaptum for now at least I think as they

spk_0 get more mature in their experience as they think on more responsibility that might change but I think

spk_0 that's the right thing to do for a younger firm with the with people that I've still growing into

spk_0 their roles you said people like to see their number go up but obviously you're an example of

spk_0 somebody where that's not always enough to keep them around so when you're thinking about

spk_0 keeping the team around retaining talent and having continuity in the investment process how do

spk_0 you balance comp versus responsibility and also just the inevitability that people do want other

spk_0 things in life so this is somebody I feel passionate about so I there was nothing that my

spk_0 foreign employer could have done to keep me there's nothing and it's not it wasn't I think with them

spk_0 I just want to start a business like I I think this is interesting as well I think I wish that I

spk_0 they have told them so I wish that we just had a conversation like hey whether you want your life

spk_0 and how can I help you achieve that and I think because we didn't have that conversation

spk_0 he assumed that I get about money me that's harder for me to kind of share what I actually cared

spk_0 about which in my case was kind of working on things I love working on but also I think having

spk_0 the fund at some point or having my own investment firm at some point and so so really with the team

spk_0 what I've been trying to do is hey well a couple things one is you know I'm giving them can't

spk_0 it feed back about how I think they're doing you know if things aren't going well I try and give

spk_0 them feedback on that even if it's sometimes painful I asked them the same thing you know I asked

spk_0 them like what's important to them you know so the people that don't seem longer have had conversations

spk_0 like what do you want you know do you want to have your own fund one day do you want to have

spk_0 trade authority do you want like what would excite you like what's important to you in your life

spk_0 and everyone's answer is different I think the default is people want more money and there's

spk_0 certainly a handful of people that want that I think for a whole of the reasons we've probably

spk_0 attracted less people that are most focused on that which frankly I'm at BWF I don't like

spk_0 wrong because people is much and it's obviously important but everyone has different things so you

spk_0 want the people on the team has made it very clear to me that they're focused on having a good work

spk_0 work life balance because they have a family and they want to be more involved in their family and so

spk_0 I'm not going to you know well one thing we could in theory do so that's what the person's told me

spk_0 so you know instead of offering that person more money and more points if I'll entertain them maybe

spk_0 it's less doing that maybe more hiring another person to take a little off that right and so I

spk_0 think my view is you just kind of talk to people what's important to them and if there are things you

spk_0 can do that pre-knowization you don't want or don't put them in the roles that you think aren't

spk_0 beneficial to the firm you try and make it a good experience for them but everyone's different

spk_0 right and you have to listen and ask them I got the thing too is if someone wants to leave like

spk_0 I someone I don't want leave I certainly want to do what I can to to retain them and I'm of the

spk_0 mind that like you really shouldn't let anyone go over compensation it's talented because it's just

spk_0 the person's reasonable it just always makes sense to retain good talent and they usually don't ask

spk_0 for more than it would cost to replace them or more it was asked for more than more than the value

spk_0 they create they use they ask for instead of having 10 to 15 percent of that can I have 25% of

spk_0 that which to me is kind of a new brainer so so I think that that's kind of part of it the other

spk_0 part of it is like if someone wants to start their own fund like that's great I'm fine with that

spk_0 like I just want them to tell me and if they tell me different things right one is I can kind of

spk_0 cater their experience to try and make it more likely they can do that so they say hey you know

spk_0 HF I think I'll start a fund in five years you're like okay great um well you know what we think

spk_0 about how you can do that these are some of the skills I think you need at some point in which

spk_0 probably issues more of LPs you know we're I don't this I don't really care about growing the

spk_0 business beyond a certain point and so hopefully we're in a situation if if people like us where

spk_0 there's kind of excess demand versus what we have available and so you know I think this could

spk_0 actually be an exciting place for someone that eventually wants to start their own fund and as

spk_0 long as I know that the person's going to go at some point and we have an open dialogue I can

spk_0 plan for that I think we've tried by bringing in younger people you kind of have talent always

spk_0 you're growing internally so I expect it to be churn I don't want to keep anyone here against

spk_0 their will I think churn over a long period of time is healthy I do hope some people that

spk_0 are here will stay here forever um the reality is these businesses don't tend to last very long I

spk_0 hope we can be the exception but we'll see how that goes but I think it's really just about like

spk_0 listening to people trying to instead of projecting what you might want um if you were in this you

spk_0 just ask and so I think by doing that but you know what we say we're going to do by making it just

spk_0 a place where there's nothing no reason to leave that's the best we can do but ultimately if they

spk_0 want to leave because they want to do something else like I just hope they'll tell me so I can plan

spk_0 accordingly and then I'll put them in as best as the best position I can put them in so they can

spk_0 achieve what they want to achieve and if they do that uh they might in my goal or hope is that we

spk_0 have you alumni out there at some point that you know are successful because frankly it's really bad

spk_0 if we have alumni out there that aren't successful um or at least aren't doing something they really

spk_0 passionate about so when people go look at us or look to join us and they talk to people that

spk_0 I used to work with they're like oh yeah you know they were great I left his while after you

spk_0 just how this you we're just enabling people they're helping me achieve my dream and my vision

spk_0 what I want my life and you know I'm here to do that for them to agree for as long as our interests

spk_0 are aligned uh but then if they want to do something different that conflicts with I want to do

spk_0 um if there's a way to keep them and allow it to make exciting for them should do that but if

spk_0 they want to do something it's fun-mally different than what I want to do and it's consistent with my

spk_0 business um that's not gonna work and so you know what can I do to help you with that and want you

spk_0 to explore that and in the meantime as long as you see it will work hard for us and do good work you

spk_0 know you have the room to kind of take your time doing and so you know I don't know a lot of people

spk_0 that do that honestly my experience has been in the past and from what I know other places a little

spk_0 bit more combative where there's a little bit more of a tense employer employer relationship and

spk_0 I just fight over compensation and different stuff and and I hope that I'm gonna be able to avoid

spk_0 that I think it that becomes more relevant as people get older and as they start to have families

spk_0 and other considerations but for now it hasn't been an issue but but my hope is by just kind of being

spk_0 able to people by them by knowing them on their side and and things that work out here they want

spk_0 something different I'm happy to help to the Greg and like my hope is that we'll retain the people

spk_0 we want to retain for as long as we can and then that one they leave you know I'll have enough

spk_0 notice they can backfill are you systematizing the training process in any way so that there will be

spk_0 a sort of HF Academy process for when people join um that's a good question a little bit so

spk_0 I've probably worked I think like six people at this point that I've kind of trained and then

spk_0 I would say it really only been trained in my career by like two people one was kind of the

spk_0 second fund they worked at we're actually think about wake the training and then last one was

spk_0 fun one where I had this phenomenal training and so I did for respects and so any one thing that

spk_0 I did strategically is I wanted someone on the team that was upset as obsessed and excited

spk_0 about mentorship as I was and one of the the people we brought on I think is very good at that

spk_0 very passion about it and so there are aspects and and that person is also Frank the lot more

spk_0 organized than I am and so we have kind of one person who brought on recently and this is the

spk_0 first one that we're I'm not doing all the training that the personally out of the team that I

spk_0 think is going to be just a great mentor to others on a team he's doing about half the training

spk_0 on things that are more model based or things where I don't think I have as much a pair of

spk_0 advantage or frankly where you know that person that we have on the team is better than I am at

spk_0 stuff whereas I'm doing more judgment related training more call work related training which is

spk_0 something I'm particularly good at more just kind of higher level PM stuff and so so I've enabled

spk_0 I've kind of I think we've created a little bit of a mentorship culture where this people like

spk_0 around the office just teach you how things are right and so there's a process I think that the

spk_0 person I work with has created to some degree that he started to employ with the people that he's

spk_0 worked with but frankly I I have my process of doing things that I've narrowed down where I train

spk_0 people and I have a way to do that which I've done for a while but then I'd outsource now one of

spk_0 that to one of the people on the team that I think's quite good at that and that's frankly a little

spk_0 bit how that worked at my last firm as well as I thought worked well and so I'm kind of

spk_0 repricating out here but it's not like we have an instructor manual or someone shows up it's a little

spk_0 more it's not as unstructured as no process but it there's a little bit of a room that I've given

spk_0 to the other team member to do as he sees fit and for what I can tell so far it's it's gone really

spk_0 while there. Thanks for listening I hope you enjoyed this special bonus episode with at

spk_0 age of reflections as I said at the beginning this is just an excerpt from a longer conversation we

spk_0 had about the hedge fund industry and I highly recommend you check out that interview if you did

spk_0 like the interview please leave the show review wherever you get your podcasts it really helps the

spk_0 show until next time

How Analyst Compensation & Incentives Impact Hedge Fund Success with HF Reflections (Bonus Episode)

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