Whether it inspires awe or disgust, industry observers love to gawk at how much money top hedge fund managers make compared with the rest of the population. David Tepper of Appaloosa Management, for example, made $2.2 billion in 2012. Ray Dalio of Bridgewater Associates made $1.7 billion. And Steve Cohen of SAC Capital Advisors made $1.4 billion. At the same time, real median household income in the U.S. for 2011 was $50,054; the bottom 80% of the U.S. population only has 7% of the nation’s wealth.
What advantages do money managers have? How have hedge funders and other members of the one percent attained their millions--and sometimes billions--of dollars? In short, what creates such inequality?
A new academic study released June 23 claims to have the answer. Titled "It’s the Market: The Broad-Based Rise in the Return to Top Talent," the draft paper says that a good education helps, but the driver of mass wealth accumulation is the scalability inherent in technological advances. It is not, however, a result of changing social norms on inequality or consolidated managerial power that funnels money to the top of the corporate pyramid.
"Skill biased technological change predicts that inequality will increase if technological progress raises the productivity of skilled workers relative to unskilled workers and / or raises the price of goods made byskilled workers relative to those made by unskilled workers," explain authors Steven Kaplan (University of Chicago Booth School of Business) and Joshua Rauh (Stanford Graduate School of Business).
For hedge funds, the new ease of managing and investing vast sums of money using computers has made a few people very, very rich.
"We believe that the U.S. evidence on income and wealth shares for the top 1 percent is most consistent with a ‘superstar’-style explanation rooted in the importance of scale and skill-biased technological change," the authors wrote.
"In particular, we interpret the fact that the top 1 percent is spread broadly across a variety of occupations as most consistent with an important role for skill-biased technological change and increased scale. These facts are less consistent with an argument that the gains to the top 1 percent are rooted in greater managerial power or changes in social norms about what managers should earn."
Both authors are research associates at the National Bureau of Economic Research and the article is slated to appear in the Journal of Economic Perspectives later this year. The paper uses hedge fund pay data as estimated annually in “The Rich List” from Institutional Investor’s Alpha.
Echoing a point made recently by Paul Singer of Elliott Management, an increasing percentage of the Forbes 400 list attained wealth through their own initiative and not inheritance. Many of the wealthiest Americans also grew up middle class and, while they benefited from good educations, did not have the advantage of growing up rich.
Of course, policy helps. “These theories, interacted with the incentive effects of taxes, regulations, and institutions, also help explain why income inequality has not risen as much in other countries such as Sweden and France,” the authors explain. “And while the private equity, venture capital, and hedge fund industries have grown in these places, they have not been scaled up to the extent that they have in the United States. Disincentives related to tax and regulatory policy may have caused both financiers and innovators in such countries to locate elsewhere, in places like London and Silicon Valley.”
It’s the Market - The Broad-Based Rise in the Return to Top Talent by Absolute Return