As a result of this deal-making, the Wall Street Journal reported that the top 5 investment banks bestowed year-end bonuses of $36 billion this holiday season. At Goldman Sachs, the payout equals roughly $750,000 for each of its 22,000 employees. Goldman’s new CEO, Lloyd Blankfein, “earned” (I use the term loosely) a bonus of $27 million, while his total compensation package topped $53 million for about a half a year’s work.Deal making, not money management, drives these bonuses, and bonuses drive Wall Street. Moneyscience.org reports that Goldman’s flagship Global Alpha hedge fund is -12% going into December.
Perhaps to turn around its flagging asset management returns, Goldman reportedly hired 17 traders from Amaranth Advisors, the hedge fund manager whose energy-bet-gone-awry cost investors more than $6 billion when it blew up last Summer.There is a disconnect between Wall Street compensation and investor returns that brings to mind the title of Fred Schwed’s classic book, “Where Are the Customer’s Yachts?”
A lot of assets are being managed by folks whose primary aim is to separate investors from their money. Big, leveraged bets are placed. Some cost investors billions, and the managers simply close down the shop and move across the street. In 2005, more than 1 in 10 hedgers had to liquidate their funds. Some bets work out well for investors, and even better for managers, who can sell that track record to pension funds across the nation who pay 2% on assets under management and 20% of profits to the managers, who can quickly attract billions in assets with the track record. As a result, hedge funds and “private equity” funds are attracting Wall Street money and talent, and investors ought not lose sight of Schwed’s perceptive observation.
The nature of leverage buy-out funds has also changed. There is less emphasis on running companies, and more people acting like “flippers” (to borrow a term from real estate speculation). Though not all hedge fund managers are cut from the same cloth as Enron’s former CEO, Jeff Skilling (who, on a happier note, finally vacated his luxurious River Oaks mansion for more appropriate living quarters in a converted college dorm room at a federal facility in Waseca, MN), Eugene Lockhart, the former CEO of New Power Holdings (an Enron spin-off caught in the midst of the deception at Enron), joined the private equity world as Chairman of New York’s Diamond Castle Holdings.
Another hedge fund recently raised $2 billion in the bond market. The fund already manages about $12-$13 billion in investor funds, and these funds are levered 7-8X, for a total of $90-$150 billion in current leverage, borrowed from major banks, that is probably senior to the bonds recently issued. Bond investors received roughly 6.5% return on their investment, as well as a return of their investment, assuming all goes well. If not, no worries, the manager is getting paid about $350 million a year in the interim. Helped by leverage and a strong market, top hedge fund managers are taking home more than $1 billion a year based on their asymmetrical payout arrangement with pension fund fiduciaries.
Why the rant? Because few would characterize this equity market as speculative, yet the sheer volume of leveraged private equity deals is a classic sign of speculation. Wall Street is not making these deals to capture gains for investors, but rather to pad their own bonus pool. Hedge fund managers live in a world of “heads I win, tails you lose” and they have been entrusted with billions of dollars of pension fund money. And the bond market and the stock market continue to disagree on where this economy is headed, with the bond market still forecasting a slowdown while the stock action over on the New York Stock Exchange is at least invigorating, and possibly exuberant. Who you gonna trust?
The bulls have the momentum. We are back to a fully invested position. But investors need to remain flexible. Though the market is not overvalued, per se, it is highly dependent on an unproven soft landing scenario. The Wall Street marketing machine says things are great, and things are great – on Wall Street.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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