Why Do Asset Owners Pay for Beta?

The Bloomberg headline reads, “BlackRock’s Hedge Fund Star Gets Paid More Than CEO Larry Fink.”  To put a point on it, the author of the article estimates that Alister Hibbert “earned a nine-figure sum more than triple the size of CEO Larry Fink’s $30 million payout.”

Hibbert manages the BlackRock Strategic Equity Hedge Fund, and “has the final call on investments,” working in conjunction with Michael Constantis and three analysts.  Here’s a chart of the returns since inception:

That’s a good decade of performance.  While there’s not much information provided regarding the tactics and exposures of the fund to figure out what the proper benchmark might be, the returns appear attractive.  The comparative chart above doesn’t easily reveal the periods of over- and underperformance, but the article says, “During the S&P 500’s worst ten months over the past decade, Hibbert underperformed just once and made money during half of them.”

Had that record been posted by a mutual fund manager, it would have drawn attention and assets — and no doubt would have resulted in attractive compensation.  But assuming that Hibbert reinvested his share of the performance fees, Bloomberg thinks he could have made $350 million from the hedge fund so far.  A bit beyond “attractive compensation.”

If the S&P 500 is a general representation of “beta,” then the fairly minor cumulative relative return for the fund over ten years seems wildly out of sync with the estimated wealth transfer.

There’s a simple reason for that disconnect, of course.  It’s a hedge fund.  BlackRock earned close to a half billion dollars in incentive fees on the fund’s performance last year, because it gets 20% of the upside, whether it’s alpha or beta.

Why do institutional and individual asset owners pay for beta?  Tradition.

When you think about it, that’s not a good reason.  Certainly last year’s net performance would have been nice to have, and such occurrences will ensure that there will be “a waiting list of investors eager to replace anyone that wants out” of the fund, which is now closed to new clients.

There are more egregious examples than this one, funds where poor relative performance and big paydays are coupled together.  At least that’s not the case here.  But it still highlights the misalignment designed into most hedge fund structures (and many other vehicles in the “alternatives” category).

Will asset owners ever design it out?