Hedge Fund Managers Scored Big. Investors? Not So Much.

Cynics often say about hedge funds are a compensation scheme masquerading as an asset class. If the critics are looking for ammunition to make their case, they need to look no further than Sculptor Capital Management Inc., the firm formerly known as Och-Ziff Capital Management.

As a publicly listed company, Sculptor offers an unusual level of transparency. While most firms guard their privacy, Sculptor files proxy statements and earnings reports, and it hosts regular analyst briefings. Last week, after 15 years in the public eye, Sculptor decided to bow out, agreeing to sell itself to Rithm Capital, an asset manager focused on real estate and financial services. The sale provides an opportunity to look back over the history of the firm and see just how successful a compensation scheme it was.

Before it went public, Sculptor had an outstanding track record. Founded in 1994 by Daniel Och, a former Goldman Sachs Group Inc. trader who came up on Robert Rubin’s famed merger arbitrage desk, its flagship fund compounded 16.6% per year through to its 2007 initial public offering. Just prior to the IPO — which was pitched to me as an analyst at a competitor — the firm managed $30 billion of assets.

There are many reasons for an asset manager to sell shares to the public. The spoken ones are “to attract and retain the finest investment management talent in the world” and to offer ”partners and employees direct participation in our success.” The unspoken ones are to enrich the founders. Sculptor took out a $750 million loan prior to IPO to make a distribution to owners. Och received around $1.1 billion from the IPO and a concurrent private placement.

After the IPO, fund performance deteriorated. Since 2007, the flagship fund returned only 5% per year. Some of that relates to market conditions, and some to a downturn in the fortunes of the entire hedge fund industry; Och couldn’t have timed his deal much better. In addition, the firm became embroiled in a bribery scandal that tarnished its reputation and led to large asset outflows.

But none of that stopped partners from paying themselves. In the 15 full years that Sculptor was a public company, partners and employees took out $4.3 billion of cash compensation, with a further $1.6 billion of equity-based compensation booked alongside it. In combination, that’s equivalent to a third of the returns fund investors took out over the period, net of fees.