D. E. Shaw cuts only hint at hedge fund pain

By Rob Cox
September 29, 2010

It’s rare for a Wall Street firm to sack a tenth of its workforce in one go. In finance, the compact between employers and their bankers and traders is simple: work hard and get paid well. But any employee is also a flexible cost that can be removed the moment business halts.

Hedge funds have a similar approach. But it’s an industry yet to experience a sustained down cycle and its concomitant job cuts. Until now. D.E. Shaw, the veteran alternative asset management shop that once employed Larry Summers, President Obama’s outgoing economic adviser, reveals the shift in fortunes.

The firm dismissed around 150 people on Tuesday, or one in 10 employees. True, such decimation looks humane compared to the blood-letting undertaken by investment banks every few years. But it represents something of a milestone for the hedge fund industry.

And it’s unlikely to be an isolated event. Since peaking in 2007, assets under management at hedge funds have slumped 29 percent, from about $2.1 trillion to $1.5 trillion this year, according to BarclayHedge. Some fund managers lost more than others, of course. That appears to be D.E. Shaw’s conundrum.

The firm, the second-largest hedge fund by employees, had around $39 billion to look after just two years ago. Today it has about $21 billion, a combination of declining markets and the firm’s decision during the crisis to restrict customers from withdrawing funds. Investors, it seems, don’t forget so easily.

While not all the money was wedged into hedge funds, assume investors paid an average management fee of 1.5 percent. The firm’s income, before its slice of any profit, would have fallen 46 percent to some $315 million. That might not be such a problem if investments were thriving and it was pocketing the traditional 20 percent of the upside.

But the math illustrates a basic point. Hedge funds aren’t so different from their Wall Street brethren. Like banks, their cost structures grew, in some cases well beyond their ability to sustain them. The good news for hedge funds, at least for now, is that the cuts only amount to a fraction of the declines in performance. That may not last.

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/