UBS O’Connor LLC, the $6 billion hedge-fund unit within the biggest Swiss bank, risks upheaval as senior traders seek to defect after a clampdown on cash bonuses, two people with direct knowledge of the situation said.
Traders are contacting other hedge funds and recruiters after UBS AG moved them to a pay structure used throughout the firm, said the people, who requested anonymity because their plans to leave aren’t public. That resulted in immediate cash bonuses falling by 50 percent to 1 million Swiss francs ($1.06 million), and some deferred pay being tied to five-year UBS bonds rather than reinvested in O’Connor funds, the people said.
The potential defections show the struggles the biggest banks may face in retaining top traders at internal hedge funds amid shareholder and regulatory pressure on pay and rules that limit how much of a firm’s capital can be invested in the funds.
“This structure is analogous to working within a bank,” said Ilana Weinstein, chief executive officer of New York-based search firm IDW Group LLC. “But what’s the likeness of O’Connor? It’s a hedge fund, and this structure is not competitive with working at another hedge fund.”
Departures may hamper CEO Sergio Ermotti’s efforts to rely more on wealth and asset management while cutting expenses by 3.4 billion francs in the next three years. O’Connor manages about one-fifth of UBS’s 28 billion francs of alternative and quantitative investments, the Zurich-based company’s highest-margin asset-management group. UBS O’Connor invests only client funds and not the bank’s, the people said.
“We believe our people choose to be here based on a combination of our team culture, access to client capital and UBS distribution,” Bill Ferri, head of the alternative and quantitative investments business, said in an e-mailed statement. “I am fully committed to continuing to grow the O’Connor business and am confident that we can credibly compete while aligning with the long-term interests of our clients and UBS shareholders.”
O’Connor offers a global multistrategy fund, a fundamental market-neutral fund, and several long-short equity funds, according to its website. The unit has a staff of about 175, including about 90 front-office employees, according to a person with knowledge of the group. Most of the personnel are based in Chicago, with others in New York, London, Hong Kong, Singapore and Tokyo, the person said.
The unit’s core Global Multi-Strategy Fund returned more than 8 percent to investors last year and more than 10 percent annually since its June 2000 inception, one of the people said. Multistrategy hedge funds fell 4.5 percent on average last year, according to data compiled by Bloomberg.
O’Connor’s trading teams report to Chief Investment Officer Dawn Fitzpatrick and the group’s traders include portfolio manager Kipp Schrage, the person said.
All employees who made more than $250,000 in 2012 had at least 60 percent of their pay exceeding that amount deferred, UBS said earlier this year. The firm also lowered its cap on immediate cash bonuses to 1 million francs last year from 2 million francs for 2011. O’Connor traders will get half of their deferred pay in five-year debt that can be canceled if UBS’s Basel III tier 1 common ratio drops below 7 percent, the people said. The ratio under fully applied Basel III rules stood at 9.8 percent on Dec. 31.
O’Connor employees got 40 percent of their 2011 bonuses in cash, up to 2 million francs, and deferred pay was reinvested in O’Connor funds and vested in equal annual installments over three years, one of the people said. There were no caps on immediate cash bonuses before 2009, the person said.
The new bonus structure pulls traders’ incentives further away from hedge funds’ traditional fee system of 2 percent of assets and 20 percent of profits, said Fabio Savoldelli, a finance professor at Columbia University in New York.
“You’ve got to look at it from the investor’s point of view,” Savoldelli said today in an interview on Bloomberg Television’s “Market Makers” program. “I want them compensated 2 and 20. You make money, you make money; you lose money, you get nothing. That’s the culture, to some degree, that you want to have.”
Most hedge funds reward employees based on the performance of the funds, with no limits on cash compensation and deferred pay most often being reinvested in the funds. Consultants who advise institutional investors on which hedge funds to invest with view pay structures like UBS’s as a risk of a bank-owned fund, said IDW’s Weinstein.
“They don’t like the risk of comp being decided by bank CEOs, because you have other competing factors, like driving up the stock and paying other parts of the bank,” she said. “There’s not clear alignment between incenting and rewarding your top-performing investment managers within the fund.”
UBS’s asset-management unit cut personnel costs in 2012 by 7.2 percent to the lowest level since 2003. That helped the division post the highest pretax profit since 2008. The alternative and quantitative unit produced 268 million francs of revenue, 14 percent of total asset management revenue, and the highest gross margin among UBS’s asset-management products.
O’Connor & Associates was founded in 1977 by mathematician Michael Greenbaum, with funding from brothers Edmund and William O’Connor, according to the 1999 book “The Predictors” by Thomas A. Bass, who wrote that the firm “made money hand over fist” and “developed a cult of secrecy.”
The brothers started trade-clearing firm O’Connor & Co. in 1959, and Edmund was the architect of the Chicago Board Options Exchange, according to his 2011 obituary in the Wall Street Journal. William, who died in 1999, was chairman of the Chicago Board of Trade.
O’Connor & Associates was started as a private partnership focused on market-making and derivatives trading, according to UBS’s website. Swiss Bank Corp., a UBS predecessor, bought O’Connor in 1992. UBS O’Connor’s traders developed the bank’s equities proprietary-trading desk before opening hedge funds to clients in 2000.