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.
In the past five years, the partner share grew even greater: Overall compensation amounted to $1.9 billion against aggregate investor returns of $2.9 billion. For a firm with just 323 employees and 99 investment professionals, that’s a hefty take rate.
Having retired from the company in 2019, such excess became too much even for Daniel Och to bear. Back in 2013, he’d authorized payment of $119 million in stock awards to a rising investment manager, Jimmy Levin, after a year in which the firm had made $4.5 billion for clients. But Levin’s pay escalated even as returns sagged.
Over the next decade, Levin rose to become chief investment officer and then chief executive officer, taking out $530 million of compensation along the way. In 2022, Och – still a shareholder in the company although no longer a major fund investor – called him out. In a lawsuit filed against Sculptor last year — but settled when the company put itself up for sale in November — Och complained about Levin’s “outsized and unjustified compensation,” highlighting that his 2021 package (of $146 million) exceeded the pay of the chief executives of nearly every other public company in the United States. Sculptor attributed the criticism to "a grudge" that Och bore against the company following his "acrimonious separation" and that his statements were “misleading and full of falsehoods.”
What’s surprising is that Sculptor’s management -- with Och at the helm — was able to accumulate such a huge compensation bill for so long despite the glare of public markets. It’s not as if the stock was doing well. Revenue peaked at $1.6 billion in 2013 and shriveled to less than $400 million by 2022. Dilution was rampant, the overall share count rising more than 40% during its time as a public company – the price to pay for “attracting and retaining” talent. Having come to the market at $320, the stock is being taken out for $11.15. (That’s a 97% decline.)
“We are immensely proud of the job we have done managing your capital over many years,” the Sculptor team wrote to its clients on the announcement of the deal, “and remain thankful for your loyalty, trust and patience.”
Following the sale, shareholders won’t have to worry anymore, although they may think twice if another hedge fund firm comes knocking at their door. Fund investors, though, should ask questions.
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