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About Those Hedge Fund Performance And Management Fees
Submitted by Dominique Dassault of Global Slant
Serial Debate About Hedge Fund Performance Fees Is Feckless While Management Fee Debate Is Legitimate.
As many hedge funds are getting “crushed” this year it has become fashionable to bash the industry’s entire fee structure…typically [but not always] 2% management fee & 20% of profits. Obviously, there won’t be too many 20% profit distributions to the portfolio management teams this year but the 2% management fee has been/will be applied. And that may “piss off” some people.
Specifically the Mutual Fund/ETF industries whom, it seems, continually criticize hedge fund fee structures. However, this is so hypocritical as many mutual funds still apply fairly egregious fees inversely related to gating periods while regularly under-performing the S&P 500. And ETF’s? Frankly they are a joke. Low fees? Sure…but the risky products they’ve developed for the mainstream retail investor [2x/3x daily sensitivities to various asset classes] are nothing to be particularly proud. Their primary incentives, it seems, are to promote increased trading activity for their particular products. Please ignore their protests of adding liquidity and hedging capabilities. It is mostly a smokescreen.
Plus, ETF’s are as close to black boxes as I’ve seen i.e. SPY. That’s why the fees are low. Basically, with rare exception, no real thinking behind them. Top heavy, market capitalization weighted indices mirroring the GIC weightings established by Standard & Poors. Their “Pitch” = Do not even try to defeat the market as it is a fruitless endeavor. Just invest in our generic products & when we do under-perform just blame The Market/ The Fed/ The Terrorists…anybody but us. The Untouchable, Un-criticizable “Soft” Asset Manager.
On the other hand you have discretionary hedge fund managers. Admittedly or not their jobs are infinitely more difficult than the typically long only, fully invested mandates of most mutual fund portfolio managers and the mindless ETF product managers. Hedge fund portfolio managers must decide among asset class, then long or short, position sizing decisions, margin utilization…etc. It is a lot and it is not simple but it is, also, a chosen profession.
This is not to say that mutual fund mangers are collectively lacking in skill. Many are supremely talented but, unfortunately, many more are not. The ETF’s, as indicated, are essentially “soft” black boxes offering intellectual short cuts to index/sector participation. It makes some sense but is surely not a panacea i.e. August 24, 2015. And there is a business model “arb-ing” ETF’s as they offer a host of inefficiencies only articulated in the encyclopedic prospectus’.
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Back to Fee Structures….
The ‘High Water Mark” feature of most hedge funds is simply AWESOME and, of course, is likely never even contemplated by the serial fee streaming strategies of the Mutual Fund and ETF industries. Basically, this feature disallows any profit participation by the portfolio managers, principal’s etc unless the limited partner’s capital account is greater than their initial capital basis [net of contributions & withdrawals].
The basic message = WE DON’T MAKE MONEY UNLESS YOUR CAPITAL ACCOUNT IS “IN THE MONEY”. Conversely, if your capital account is “OUT OF THE MONEY”, no performance fees [and in rare cases no management fees] are applied until your capital account is, at the very least, break-even. I’ve yet to meet any limited partner that objects to this feature…the feature NEVER articulated by the penny pinching “I don’t care if you make money as long as my firm makes money” Mutual Fund/ETF sectors.
Their two business models generally rely on dubious skills more tilted toward marketing and hand-holding rather than a strict pursuit of consistent capital building. Because despite their efforts to dissuade…a fair amount of performance is timing related. When the returns do not fit their marketing materials they’ll simply stretch the time frames in which returns are calculated…shaping the facts to fit their predetermined conclusions.
Some may argue that the “High Water Mark” is somewhat misleading as the 2% management fee, for example on a $500M fund, equals $10M. So somebody is making money. Surely salaries, rent and other fixed costs usually do not equivocate this number…especially considering the soft dollar expense paying feature many funds enjoy that is tied to their trading activity. That can free up a great deal of the management fee to boost incomes across the firm’s labor force…which is not entirely a bad thing but does seem moderately flawed…as it rewards short term trading activity that is not necessarily wise trading.
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Therefore it is time for the Hedge Fund Management Fees [2%] to be COMPLETELY ELIMINATED.
INCOME TO PORTFOLIO MGR = STRICTLY LINKED TO THE PERFORMANCE FEE. Might as well term it the COMMANDO INCENTIVE FEE STRUCTURE. And there are some funds that adhere to this precept but not too many. Some that do actually charge greater than 20% of profits or may attach profit sharing to terraced, and agreed upon, performance criteria. Again…no problem with that. And perhaps the payouts are 2/x year rather than calendar based? No problem.
Controversial = Yes. There is bound to be a fair amount of push-back Some hedge fund mangers could argue that this will increase the stress level/decision making capabilities of an already hyper-stressed analysts/portfolio managers. Perhaps…but I say “TOO BAD”. I suggest they “LEAN INTO” the stress and contemplate that it could actually result in more distilled/cleaner decision making. And it is important to reiterate that a lot of a hedge fund’s expenses i.e rent, legal, accounting, etc are still soft dollar-ed with trading commissions. Yes…not all expenses but, recall, you are not supposed to get rich just by raising capital, “showing up” and trying. The real goal = returns on that capital. And still…just perform and large amounts of money will be EARNED.
The era of the wealthy hedge fund manger living the “HIGH LIFE” primarily due to the 2% management fee [while just not “Blowing Up”] are primed to change. Beyond this…liquidity and transparency are “on deck”…and, it seems, even a strong legacy of performance will not interrupt this dynamic. Nevertheless, it is a much fairer/better business for an investor than the Mutual Fund/ETF sectors.
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are etf's really that bad? I have done ok trading them in short term. I dont have easier access to assets some of them claim to represent
Hedge Funds? Who cares.
They are all running a Ponzi scheme and unsustainable theories.
I think the 2% is a tax deduction?
Dominique Dassault is clearly an idiot.
What does he think the firms creditors will do, let the funds off if they don't make any money?
Let me see, office rents linked to fund performance. Where have I heard that one before... Ah, nowhere.
Dealing w/ seniors is a cha hing industry.
The concept of trading a fund like a stock is still hard for me to get my head around. My old man bought into some mutual funds when they first became popular. Some of them were still in his portfolio when we settled his estate.
Did he make any money on them?
Yes and no. He wasn't a careful investor and took advice from from colleagues and the WSJ. He was still holding a lot of DuPont common when he died along with other Dogs of the Dow. He got killed on things like Global Crossing and other internet bubble crap. He'd probably watch Jim Cramer if he were alive today.
What they promise and what they actually deliver. The sheep don't read the fine print before they sign, but always complain when they get sheared. It's the same things with the college loans, Your an adult, your responsible for reading before signing...always read the fine print.......
How the fuck can you charge a management fee if you have made a loss for your hedge fund?
If you beat the S&P 500 by 10% then you can take about 5% of the profits. If you beat it by 50% then you can take a maximum of 25% of the profits of the fund. But half of that goes into escrow for 3 years. If any loss in the next 3 years, then profits held in escrow are returned to customers
Even if you beat the S&P500 by 100%, you only get a maximum of 25% of the profits of the hedge fund. But they are held in escrow for 3 years to compensate for any losses.
This caps the total fees to 12.5% in a calendar year with 3 years of no-losses to get the remaining 12.5%
That would be more fair. But fairness is a virtue alien to hedge funds.
Clearly you haven't worked out yet that these are businesses, with rents and salaries to pay.
Win or lose they still have to pay the bills, so as long as it states the terms in the prospectus, who the hell are you to tell them what they can or can't or should or should not charge? Is your arse on the line if these companies go bust?
Your only input is whether you choose to invest or not, and that is entirely up to you.
This author is an idiot. What does he think they are, charities?
Yes, bills for the luxury Manhattan 'leg-spreader' apartment, country club dues, parking for the exotic sportscar, plus monthly budget for rare wine. And that doesnt cover the wife, kids, or mistress.
Oh, and let's not pretend any of these fuckers have their 'arse on the line'. Less than 2% of 'em have ANY operational responsibility for their portfolio businesses.
Hedge funds are setup to greatly enrich their operators, then (maybe) enrich their investors.
If it goes south, there is a boiler-plate 'shutting fund' press release.
LET ME KNOW IF YOU NEED ME TO FIND IT FOR YOU.
Every company has shareholders somewhere, who invest in a business to make money. It goes bust they lose. period.
Neither is it my place to criticise someone for spending their income on things you're clearly very envious of.
'Hedge funds are setup to greatly enrich their operators, then (maybe) enrich their investors.' Name me one business that isn't.
The rest of what you say is all horseshit you just made up. Frankly, you don't seem to have too great a grasp on reality.
Boy - that sounds like you are defending and arguing for a (pretty angry) hedge fund (manager)?
Sounds like you just had a bad, a very bad 2% year?
Condolences from my heart.
BTW: taking 2% from idiots for providing monopoly access with real money - as long as there are such idiots - is quite Ok in my book. They really deserve it!
If you deal with sharks/banks, goriallas/CBs and crocodiles/HFs - you are well advised to expect this or that leg/dick or head to be cut off. Some never learn - they deserve to be eaten alive. Natural sustainable very healthy development.
I don't invest in hedge funds. Nobody looks after your money better than you do.
Read the documents, if it says there is a risk then there is, and if you don't like it, don't invest in it.
But I do vigorously defend your right to set up a hedge fund and charge what you wish if you choose to.
Whether I choose to invest in it is another matter.
These are not businesses. There is no such thing under Crony Crapitalism. They are rent seekers, cashing in on government placement of the cheese in the maze (tax code and inflation)
Pimpin' ain't easy!
hypothetical. years 1-7 they jam the momos higher with opm and leverage taking 20% of the paper gains every single year. year 8 the fund loses 100% of the client's money. who wins in this scenario?
Goldman?
that goes without saying. lulz
The bullshit from the ETFs is that the hedge funds trade them too.
And those 2x or 3x long/short funds? You might as well play craps.
Usually, dice aren't manipulated and the odds are better and are based on math. So hell yeah, roll them bones instead of BGZ.
Poorly constructed analysis. But the point is valid. Hedge Funds are a scam and should be illegal. All in the name of generating Alpha bullshit. All upside with no downside. When times get tough, gate, liquiate over time, close down the fund and open up a new one. Just another example of rigging the system and greed of financial elites.
Good book: Money Mavericks: Confessions of a Hedge Fund Manager.
'Hedge Funds are a scam and should be illegal.'
A hedge fund is a business that says it will make money by doing this, that and the other. Its terms are laid out in a prospectus, and from the ones' I've read I'd say the risks section is usually pretty comprehensive.
Whether it makes money or not is irrelevant, unless it states categorically that it definitely will make money, and I've never read one that did.
How is that a scam, and why should it be illegal?
You have the right to set up your own hedge fund do you not. Why would you rather have that taken away?
Surely the issue here is due dilligence?
it should be illegal because they bribe/trick pension fund managers into investing in what is clearly a losing proposition for the public.
The only way I could agree with that is where a hedge fund manager changes his strategy (possibly because he is consistently losing money), but other than that it sounds like the problem here is the pension fund managers, who should know full and well the implications and risks of investing pension fund money in any hedge fund.
As long as the hedge fund states it terms fully in the prospectus then I don't see the problem with it.
The premise is that the Hedge Fund Framework should never have been allowed to exist. But Hedge Fund lobby, along with some shit hot lawyers, figured out a way to game the system (all upside with no downside risk. Apparently not even Reputation Risk matters as they just show up in the future at another fund). Case in point:
Amaranth Advisors: A 32-year-old trader named Brian Hunter was blamed for a $6 billion loss on disastrous gas bets, which precipitated the Greenwich, Conn. fund’s collapse in 2006. Another hedge fund, Citadel, swooped in to buy the remains of Amaranth’s portfolio.
http://www.newsweek.com/rogue-trader-who-got-away-it-271105
https://en.wikipedia.org/wiki/Brian_Hunter_%28trader%29
No1: Pension Funds should have never been allowed to invest in Hedge Funds. Only reason they do is to make enough returns to match their future liabilities.
No2: The bullshit about Qualified Investors simply exonerates the HF Manager. Puts the onus back on the Investor. Smart.
No3: Look at the numbers. Say as a HF Manger I am fortunate enough to attract a USD2bil fund. I run a 2 and 20 fund. 2% Management Fee and 20% Performance Fee. Say I have a modest 6% Hurdle Rate. I simply invest in S&P 500 Index. Returns of S&P from 2009 to 2014 below. Keeping Fund at USD2bil for simplicity. Not compounding the returns. My returns as HF Manager as follows:
2009, +23.45% - MgmtFee = USD40m, PerfFee = USD69.8m, Total Rev = USD109.8m
2010, +12-78% - MgmtFee = USD40m, PerfFee = USD27.1m, Total Rev = USD67.1m
2011, +0.0% - MgmtFee = USD40m, PerfFee = 0, Total Rev = USD40m
2012, +13.41 - MgmtFee = USD40m, PerfFee = USD29.6m, Total Rev = USD69.6m
2013, +29.6% - MgmtFee = USD40m, PerfFee = USD94.4m, Total Rev = USD131.4m
2014, +11.39% - MgmtFee = USD40m, PerfFee = USD21.5m, Total Rev = USD61.5m
Total for 5 good years and 1 bad year = MgmtFee = USD240m, PerfFee = USD242.5m, Total Rev = USD482.5m
That is nearly half a billion over 6 years to invest in an index.
Now USD2bil is a modest size hedge fund. Some of these funds go into the stratosphere. Just becomes trailing zeros as framework is the same. 2 and 20.
http://uk.businessinsider.com/20-biggest-hedge-funds-in-the-world-us-uk-...
Some of these Managers are making over USD1bil per year.
http://www.forbes.com/hedge-fund-managers/
And when times turn down, they simply roll up shop, return investor money, go play for a few years until the investment cycle returns and then start up the game all over again.
Case in point, BlueCrest returns investor funds:
http://www.zerohedge.com/news/2015-12-01/legendary-hedge-fund-calls-it-s...
Michael Platt at Bluecrest - USD800mil.
http://www.institutionalinvestorsalpha.com/Article/3450284/The-2015-Rich...
Then the chaps that tanked Bear Stearns back in '08 show up at Stone Lion Capital just to do it all over again.
http://www.zerohedge.com/news/2015-12-12/eerie-echo-2007-it-really-bear-...
Scam? I would say so.
'Another hedge fund, Citadel, swooped in to buy the remains of Amaranth’s portfolio' you imply that there is something wrong with this? It is what normally happens in any bankruptcy in any business.
No 1- true, but that's not the fault of a hedge fund.
No2 - The onus is only ever on the investor. As long as the fund manager hasn't lied or misled in the prospectus then there was only ever one party responsible for deciding to invest in a hedge fund.
No3 - I don't see your point. It is not illegal to make money even if you are investing in an index. Don't like it don't invest in it.
'Some of these Managers are making over USD1bil per year.' so what? If they haven't lied about what they do in the offering document can you complain about it?
'And when times turn down, they simply roll up shop, return investor money, go play for a few years until the investment cycle returns and then start up the game all over again.' So don't invest in it then. It's your choice.
'Then the chaps that tanked Bear Stearns back in '08 show up at Stone Lion Capital just to do it all over again' That's not illegal, and neither should it be. I wouldn't invest with any one of them, but if they've told you that in the offering document then you can't compain about it.
It's only a scam if they lied to you to get you to invest. Other than that I see nothing wrong with them or anybody else making money by providing a service, regardless of how effective they or it might be, and I see nothing in what you've said that might cause me to change my view..
I think you've missed the core problem entirely, they know very well what the implications are to their potential vacation home in Boca Raton.
It's hilarious how the hedge fund world INSISTS on their '2-and-20', yet when it comes to paying for market intelligence, they are the cheapest bastards in the world. Investors should hear them, and use the SAME arguments. 'Ehhh, if you invest my funds profitably, THEN you'll get a management fee.' 'Ehh-ohh! Let me free-sample your portfolio mgmt skills for 9 months. If I see the value in it, I'll pay you what I think it's worth'. 'We're really cheap, but evetually we'll get you paid'. Why would anyone pay a 2% mgmt fee if they aren't getting a better-than-the-market return (if not in absolute terms, then in risk-adjusted terms)? Hedge funds have underperformed the indices for as long as QE has been bubbling equity markets. . .
Well, since that information cost is usually a fund deductible expense, then any savings would be passed on to the fund, and then onto the investors wouldn't they?
Pass on the savings to the investors . . . that's rich. Same idiocy in health care policy I deal with if health insurance benefits weren't tax deductible and employers left health insurance all together that they would give this money to their employees instead to purchase health insurance. Yeah right, sure.
Same thing locally in PA when the local GOP rep just a week ago tried to tell me that if they got rid of property taxes (which the House GOP is trying to do with the latest budget) that landlords would lower rent. I went to the mic, said I was a landlord with 3 rental properties, and I wouldn't lower monthly rental rates by $1 on any of my units unless they sat empty for 2 (maybe 3) consecutive months. I'd simply either bank the windfall or reinvest it other ways. He stated I didn't understand, I told him I had an a Ph.D. in econ, and had lengthy experience in the rental market in Reading, State College, and now in West Chester. He was quiet, said he would have to look into it, and get back to me. He knows it is a pure BS answer that landlords would lower rents if property taxes were removed unless local market vacancy rates forced them to do otherwise.
I don't see how this has got anything whatsoever to do with my comment.
Thanks for posting...
I wonder what would happen if all zerohedge posters withdrew their cash & assets from all funds Monday morning. Systemic collapse I'm guessing since we're an enormous slice of the so called market.
I get the feeling that a lot of zero hedge poster are actually unemployed anarchists, and might not have a huge amount of invested assets.
But I may be wrong...
cant speak for anyone else here but i;
think government is a great idea, it keeps a spot light (media) on the people you wouldn't trust in the dark (people who would want to govern).
and
have investments and assets
You are not an enormous slice of anything, much less the market. You are outnumbered by teachers, prison guards, and working stiffs by 1000:1, and easily 20:1 by assets.
This show could not have been running this long otherwise.
I have 2 friends from my econ Ph.D. who work for hedge funds (quants and not the idiot finance MBA guys who played lacrosse but can't hack the math) along with a cousin in Boston.
Just think of it this way - whenever a financial or insurance firm or type of firm vehemently resists even the most basic efforts at financial transparency including simply even being forced to register the basics of their products and information about their firm or refuses to allow a single, peer-reviwed broad study by an external third party to compare hedge fund returns against others investment vehicles you know something is inherently wrong.
Is something looks like and smells like a turd, it generally is a turd.
If you think the fee will piss them off wait until they close redemptions on their roach motels.
I have yet to hear one hedge fund guy really give me a compelling reason on why hedge funds are really a necessary class of investments and provide a broad purpose to enhance financial markets & society as a whole. The first line of defense is that they'll tell that you either don't understand or that you are a socialist/marxist/etc. I say to them 'no I have the academic training and analytical understanding to understand them but explain it to me like an engineer is trying to add something complex to an already complex system.'
They'll get into shit about active management and how there are large numbers of clients who need their services for portions of their investments to seek outsized alpha returns. That's all fine and good but it still doesn't the later part of my question. Then they'll default to their role into providing liquidity into the marketplace with the current rules (Volcker Rule) which I would agree with because of some shoddy legislation governing US financial markets in that regards. Change them and the liquidity role that hedge funds plays largely goes away too. I have serious doubt too that when the shit hits the fans that the hedge funds guys will provide anywhere near the liquidity the market needs too as they already either were out the door or are quickly on their way. Hedge funds when you get down to are modern-day shylocks.
The only investment advice that's worth paying for is of the inside persuasion.
ETF? That's the name of the game where it's "heads we win" or "tails you lose." Only way to win is not to play.