Getting By on $600,000 a Year

Further underlining the perils of starting a hedge fund, I was recently having breakfast with a friend who runs a successful long/short hedge fund with about $60 million in assets. He seemed stressed. “It’s hard to make ends meet in this business,” he told me.

“What do you mean? Your business has been doing great,” I said. “You’ve beaten the market every year. Your business is growing.”

“Listen,” he said, “let’s go through the breakdown. Let’s say you have $60 million in assets and you charge two and twenty.” He’s referring to his 2 percent management fee (a fee taken as a percentage of all assets) and his 20 percent performance fee (a fee taken as a percentage of profits). “So that’s $1.2 million in definite cash flow for the year. Plus another $1.2 million if I return 10 percent on the year, so $2.4 million. About half of the money I’ve raised was through a third party marketer. The deal is I give the third party marketing firm 20 percent of the fees I make. So that’s $500,000 out the door. I’m down to $1.9 million. I have three professionals working for me. One does admin, client relations, and so on. That’s a fulltime job. Two help with stock picking, trading, risk management, due diligence, and so on. They average out at $150,000 each plus insurance, so that’s about $500,000 out. By the way, don’t print my name. I don’t want them to know what the average salary is between them. So now we’re down to $1.4 million.

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“I have to have a good office. I bring clients up here, show them around, everyone hard at work, nice views, and so on. Fifth Avenue address. That's $10,000 a month. Then a secretary, office supplies, and so on, somehow or other adds up to about $80,000. Let’s round it to $100,000 after including travel expenses, and so now I’m down to $1.2 million. Well, I have a partner—the guy who helped bring in the initial $15 million to get us started—and he meets all potential clients that the third-party firm sets up and he also finds new clients. He’s on the road all the time trying to raise more money, going to conferences, and so on. So my partner and I split fifty-fifty. Now I’m down to $600,000 for me.”

“You realize, of course, that this puts you in the top 99.9 percent of income for the global population,” I gently reminded him.

“Well, let’s go through it. First off, taxes take out about $250,000 for me. So now I’m down to $350,000. Mortgage payments on my 2,200- square-foot apartment are about $8,000 a month, property taxes another $2,000. That's $120,000. Two kids going to private school plus all the expenses that entails—supplies, piano lessons, religious stuff, and so on—that’s about $50,000, bringing us to $170,000. Where am I going to stay in the summer? All my kids’ and wife’s friends are in the Hamptons. A Hamptons house is going to cost me another $50,000 at least. I’m being generous here. Camp for kids—let’s say another $15,000. Now we’re at $235,000. Let’s add up basic household staff: nanny for kids plus housekeeper adds up to about $60,000. Now I’m at $295,000. Well, now between my wife and me we probably average about $1,000 a week on everything else: food, entertainment, furniture, HBO, travel—two vacations a year are going to cost me about $10,000 each one—and so on. Again, I’m being very generous. I don’t even think I’m counting clothing or dry cleaning costs here. But this takes me to right about $350,000.

“And let’s not forget,” he adds, “this assumes I’m up 10 percent this year. Right now the S&P is down about 0.5 percent and all the hedge fund indexes are hanging out around flat. I’m up 4.8 percent on the year so I’m killing all of them. But here we are eight months into the year and I’m on track to do 6 or 7 percent. Being up 7 percent instead of 10 percent would lop about $90,000 off my yearly take. So in a year where I am totally killing it I’m not even doing as well as in the scenarios I just described where I can’t even make ends meet.

“And further. What happens when this SEC regulation kicks in? I have to hire a compliance officer. Right now, today, as we sit here, compliance officers are making between $200,000 and $500,000 a year. What happens when funds are required to hire a compliance officer? There’s about 3,000 funds that are going to have to hire one. Do you think there are 3,000 unemployed compliance officers out there? What’s this going to cost?” My friend threw up his hands and I just didn’t have any answers for him.

This conversation reminded me of the excellent 1980 book by Andrew Tobias, Getting By on $100,000 a Year, which I highly recommend, which details similar scenarios, albeit in pre-hedge fund days. All of this is to say, I think the hedge fund business, just like the Internet business, is quickly becoming institutionalized, and ultimately only the big players will survive, with the rest either disappearing or getting acquired through rollups of funds. Personally, other than starting a hedge fund, I think one of the better business models out there is to raise money to buy stakes in the management companies of smaller hedge funds that may need help on the financing side once they realize the money doesn’t fall like manna from heaven.

Good Investing,

James Altucher

Extract taken from SuperCash: The New Hedge Fund Capitalism, Copyright © 2006 By James Altucher. Reprinted by arrangement with John Wiley & Sons, Inc.

Editor’s Note: James Altucher is a partner at the hedge fund firm Formula Capital. He writes for TheStreet.com and the Financial Times and has been a periodic guest on CNBC's Kudlow & Cramer. Previously, he was a partner with the technology venture capital firm 212 Ventures and was CEO and founder of Vaultus, a wireless and software company.