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Editor's Desk: Top Hedge Fund Managers May No Longer Rake in Billions of Dollars a Year

Alpha magazine dropped its first shoe when it released the salaries of the top 100 hedge fund managers, with the top master of the universe, James Simons, earning an astonishing $1.7 billion in 2006 and the top 25 an average of more than half a billion. In 2006, the compensation of this top 25 soared 57% from the year before and 127% from 2004.

A handful of news outlets ran the story, many condemning the nine- and 10-figure salaries as "obscene," "sheer avarice," "incredible greed," "inequality not seen since the 1920s"-and even "inherently immoral." The New York Times referred to this elite group of hedge fund managers as "alpha males...winning the Darwinian competition for capital."

And to put it in perspective, ABC News reported that "Alex Rodriquez is the highest-paid baseball player in America, $25 million per year. But in order to match the earnings of James Simons, A-Rod would have to play until he's 100."

So are these guys worth it? Certainly, the biggest hedge funds tend to deliver above-market performance and can get away with charging investors as much as a 5% management fee and 44% of profits.

But here's the other shoe to drop that's likely not only to get investors outraged but thinking twice about hedge funds. Last year, according to Hedge Fund Research, the average hedge fund returned 13%, trailing the S&P 500 Index's 14% gain. And since 2000, the average hedge fund, after fees, has only kept up with the market.

With all of the money flowing to hedge funds, particularly from pension plans, it will be increasingly difficult for hedge fund managers to find undervalued investments and deliver outsized returns. And as we report in this issue, hedge funds are now looking to appeal to a broader audience and lowering risk, and with that, perhaps sacrificing returns.

There have been recent reports that with hedge fund performance disappointing of late, some institutional investors with large hedge fund stakes are pressuring them to lower their fees from the standard 2% of assets and 20% of profits above a benchmark.

As Robert Discolo, manager of a hedge fund-of-fund at AIG Global Investment Group, told BusinessWeek: "In most cases, [managers] don't deliver enough to justify their fees. Most funds are doing things that can be replicated much cheaper."

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