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Morning Coffee: The best bit about private equity jobs has disappeared. Bonus cap demise is going to cause friction

When is an expected double-digit pay rise bad news?  As any banker who lived through the lean years of the 2010s will tell you, the answer is that it’s bad news if it’s happening instead of a bonus rather than as well as a bonus.  And now, it seems that the private equity industry is heading for a similar situation.

People contributing to the latest private equity industry pay survey being carried out by Odyssey Search Partners aren’t exactly crying into their beer yet – total cash comp expectations are 13% up, many of them have guaranteed bonuses, and in any case, salaries and bonuses are usually paid out of management fees rather than performance fees, so they’re not as volatile as the sell side.

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But that is exactly the problem – volatility in compensation is a good thing, if it’s driven by occasional massive bonanzas.  The reason that young investment banking analysts go through the late nights and absurd selection processes to get into private equity is that they dream of one day getting “carry cheques” – the carried interest paid to senior partners from the profits made on successful deals. 

These are not only often huge sums of money – often as much as nine times the salary and bonus – but they can also benefit from the notorious “carried interest loophole” (and its international equivalents), which taxes them at a long term capital gains rate rather than as income. 

And, in an environment where there are no deals, there’s precious little carry.  So although the average figure is up 13%, that’s made up of an expected 21% increase for analysts and 8% for principals, while Managing Directors at private equity firms are expecting flat pay, at a median value of $1 million.  At that sort of money, you might as well have stayed at Goldman Sachs.

Nobody’s likely to shed many tears over this.  Which could be all to the good – can you think of anything more humiliating to a private equity titan than being pitied by their coverage banker?  But it could have long term implications for the industry if it persists.  According to John Rubinetti at recruitment firm Heidrick & Struggles, “nobody’s really panicking”, and other recruiters agree that private equity funds need to hang on to their talent as they wait for a recovery.  But nobody’s getting excited either.

Big carried interest payments are to PE firms what stock options are to Silicon Valley – they’re one of the few ways that employees can build genuinely dynastic wealth.  They’re the thing that attracts the brightest young people into the industry, and they’re the golden prize at the top of the tree that keeps them aggressive once they’re in.  If the megabucks aren’t there for a few years, it all starts to look like a relatively normal industry.

Elsewhere, one of the under-looked second order effects of the UK bonus cap removal is that it’s going to create a lot of “haves” and “have-nots” among senior bankers based in London.  Since EU-regulated firms will still be offering high-basic-salary packages, it’s going to be difficult for any bank to completely reorganize its compensation structure overnight.  So what’s likely to happen is that the current generation of MDs will continue with what they’ve got, while new promotions will be to a more old-fashioned mix of a basic salary not that much higher than the other ranks, but much higher bonus potential.

That’s likely to cause a lot of friction, particularly in tougher market conditions.  In the olden days, before the practice was banned by the FCA, multi-year “guaranteed bonuses”, paid in order to recruit top bankers from other houses, used to be a reliable source of bitterness on trading floors in bear markets.  Not only were some of the bankers not exposed to the same downside, but their guaranteed packages tended to eat up the whole compensation pool and have a “leverage effect” on those who didn’t benefit.

A mix of high-base and low-base employees is likely to have a similar effect.  Particularly when you consider that it will also have a generational bias (low-base MDs will be younger) as well as a national one (US expats will tend to be transferred on something closer to their existing package rather than made up with “allowances”).  Get ready to hear the phrase “well it’s all right for you” a lot more.

Meanwhile …

Massive congratulations to midcap bank specialist John Pancari of Evercore ISI, who is not only an Institutional Investor All-American Team member for the first time this year, but will also enter a less formal sell-side analysts’ hall of fame, by being the greatest example possible of the fact that the research game isn’t just about stock-picking.  He gained his ranking despite having been “constructive on SVB Financial’s discounted relative valuation heading into the March–April 2023 deposit run”. (Of course, for SVB it was only a March deposit run, they were long since gone by April).  In a lesson to every analyst who has come in to see a big red number on the screen, he kept communicating with investors, didn’t try to double down and has apparently been rewarded for doing so. (Institutional Investor)

A guide to the favourite lunch spots of top Australian bankers.  Or possibly, to the restaurants that top Australian bankers have been told not to expense any meals at until revenues turn back up. (AFR)

Some people are born survivors – 45 Credit Suisse analysts, mainly in APAC, have been kept on as members of the UBS Research team (Financial News)

And it seems that the investment banking data analytics team, “Strategic Insights and Advisory”, is going to be made up by simply combining the corresponding UBS and CS operations.  Clearly this must have been a shortage area for recruitment. (Finews)

Jefferies rings the bell next to its “MD hires” scoreboard again, as veteran industrials banker Francis Tucci joins from Citigroup. (Reuters)

Steve Schwarzman of Blackstone says that people working from home enjoy a “lighter workload” and save on commuting costs and buying business clothes.  At CEO of one of the world’s largest owners of office real estate, he’s an objective voice on this. (Bloomberg)

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AUTHORDaniel Davies Insider Comment

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