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Editor’s take: The alpha, the beta and no mega pay anymore

With record bonuses to be paid, now may not be the time to suggest that it’s getting harder to make a fortune in financial services.

Take fees, for example. Announced M&A deals may be at record levels, but with the biggest deals still not complete, banks have earned less from this year’s frenetic deal-doing than they did in 2005.

Fees earned are but a pebble, however. It’s ‘transparency’ that’s lobbing the mightiest boulders on the road to riches. Like it or not, it’s becoming clearer for banks, hedge funds and asset managers just how much of employee performance is down to sheer brilliance, and how much is down to piggy-backing on the back of market events and an organisation’s good name.

After months of avid hiring, recruiters say banks are now fully acquainted with the market value of their sales staff and are preparing to pay precisely that – and no more. “These days, banks know exactly how much their salesman flogging equity derivatives to Italian corporates should be selling,” says one. “They’ve probably interviewed all his competitors and they’ll pay accordingly.”

Transparency is also making its debut in the gigantically generous and historically opaque hedge fund sector. Jonathan Evans, managing director of search firm Sammons Associates, says some sellside analysts have begun avoiding hedge funds like a highly contagious medieval disease. “Hedge funds put you under the microscope,” he explains. “If you don’t deliver, you get found out [and don’t get paid].”

However, hedge fund types who think their performance is already highly scrutinised may be shocked by what’s to come.

Narayan Y. Naik, a professor specialising in hedge funds at the London Business School, has been busy constructing a computer model that emulates hedge fund performance. Naik predicts that, in as little as six months, the model will be used to create a performance benchmark against which to measure hedge fund managers’ efforts.

According to Naik, the benchmark will shine a light on how much of hedge fund returns are down to alpha [managers’ skill] and how much are down to beta [movement of the market]. Until now, managers have argued all their achievements were down to alpha, and have been paid accordingly. “The writing’s on the wall,” says Naik. “Fees will definitely come under pressure.”

Hedge fund professionals aren’t the only ones with no place to hide. Private equity funds – best known for making multi-millionaires on a slow burn, are also being exposed as not-so-alpha-generating after all. Research from Citigroup suggests the returns offered by private equity funds can be bettered simply by applying high levels of leverage to publicly traded stocks.

So … if private equity and hedge funds don’t pay up any more, what will?

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