Hedge fund math = regular math. When you charge 2 and 20 but have slim or negative returns, the 2% dominates the 20%. Investors don't like the fixed part of fees, and want to be able to claw back some of the variable fees when later years are bad. Note that this already happens in reverse due to high-water marks (e.g. if you lose 20% one year and then make 25% the next, you don't get a performance fee since you're just back to even). Some investors would like to be able to do the same but in reverse.
In my mind, this is a business like any other. With more competition the price goes down. For HF that means lower fixed fees, higher hurdle rates, lower variable fees, or some combination. On top of that, you can look at it like any risky contract. If you want lower fixed fees, you'll have to pay more in variable fees, and your expected cost will be higher as the managers bear more risk
>Hedge fund math = regular math. When you charge 2 and 20 but have slim or negative returns, the 2% dominates the 20%.
That's not the real problem. That part is intuitive. The real issue is that "20% of profits + 0% of losses" is equivalent to "20% fee, also you give them free money when the stock drops". People tend to focus on the 20% and that leads to highly inaccurate expectations.
some historical context...the problem is that the 2 in the 2 and 20 hasn't come down as asset gathering exploded.
When hedge funds first started the pools of capital were much smaller, and the management fee was there to keep the lights on, and provide the cash flow stability to pay top people etc. (essentially cover overhead). As AUM exploded, especially at the largest funds, management fees became a profit center...this has changed a lot of incentives...
This is nothing like regular math. It isn't even like its closest competitor: private equity. They only get to take performance fees on exits, which can take years or even decades (or never) to materialize.
> It isn't even like its closest competitor: private equity. They only get to take performance fees on exits, which can take years or even decades (or never) to materialize.
I would argue that private equity is much worse on fees than hedge funds. Among other offenses, they're able to charge fees to both portfolio companies and investors. The investors usually get a credit for the fees paid by portfolio companies, but it's not a 100% offset.
To an outside observer, this seems to buy you performance that isn't too different from exposure to infrequently marked leveraged standard risk premia.
Private Equity has its own little scams, no doubt. But that doesn't excuse the hedge fund business's "top tick" performance fee scam. Basically, a person like Ackman and some friends could (in theory) bid up a stock 1000%, mark it there at the end of the month or year (or whenever they account for the performance fee), take their performance fee on that mark, and let it crash. In fact, doesn't that sound a lot like Valiant? 30% of the company was owned by Ackman and people close to him.
> Basically, a person like Ackman and some friends could (in theory) bid up a stock 1000%, mark it there at the end of the month or year (or whenever they account for the performance fee), take their performance fee on that mark, and let it crash. In fact, doesn't that sound a lot like Valiant?
How much do you think Ackman lost in personal money on Valeant? You don't think it's much more than the performance fees that he earned from it?
Venture Capital charges huge fees. The Kauffman Foundation had a study in 2012 [1] of their VC investments over the previous 20 years, and concluded:
* 78% of funds did not return enough to justify investment, given the risks and long lock-up.
* The average VC fund fails to return investor capital after fees.
PE as a whole hasn't done much better [2].
It's a dismal industry – for investors, that is, not necessarily for the employees.
Hedge funds and PE firms aren't typically direct competitors. The goals and risk profiles of the funds don't typically align (and hedge funds aren't monolithic as a group, either), but beyond that, there are typically regulations governing which entities can invest in which type of funds. The LPs in big PE funds tend to be large institutional investors--pensions, endowments, and the like. Hedge funds tend to have mostly high-net-worth clients.
> The LPs in big PE funds tend to be large institutional investors--pensions, endowments, and the like. Hedge funds tend to have mostly high-net-worth clients.
The LPs in big hedge funds also tend to be institutional investors.
Isn't the buying and selling of a stock in a hedge fund analogous to an exit? They happen more frequently that deploying capital, but the only big difference is that in a hedge fund you're expected to reinvest that money. So the math is exactly the same as in a PE fund. If a trade or portfolio company tanks, you won't make your performance fee on it.
PE companies also can charge fixed management fees.
In my mind, this is a business like any other. With more competition the price goes down. For HF that means lower fixed fees, higher hurdle rates, lower variable fees, or some combination. On top of that, you can look at it like any risky contract. If you want lower fixed fees, you'll have to pay more in variable fees, and your expected cost will be higher as the managers bear more risk