Incentive/Profit Fees Crystallization Frequency

TSWP · Post by **TSWP** » Thu Sep 17, 2015 10:23 am

I disagree with sharing the loss with the investor.

The investor has the capital and places a calculated bet with an investment manager, the bet is risky but if well placed it will payoff.

The manager instead brings the "know-how", the technology and the infrastructure to produce returns on investments. The manager's risk lies in running the business (entrepreneur risk) and in building/handling the trade secret/s that will make his business successful and if it is a valuable trade secret it will take many years, a lot of work and a lot of money to build, and the risk here is all on the shoulders of the manager: the risk of business failure.

To me the division of risk between investor and manager, at the start of a fund, is: investor risk=capital, manager risk=business failure.

(other risks may be present but let's keep it focused on the main risk)

The manager initially will have little or no skin in the game, but as his wealth grows he can (he should) invest part of his earned money in his own fund, to show the investors that he is also participating in the risk. That is how the manager can, at one point, share the loss with the investors, but he is also profiting from having skin in the game so this is not a share-the-losses scheme, the risk-sharing is just a side-effect of the action of putting his own money at work for profits.

Baltazar · Post by **Baltazar** » Thu Sep 17, 2015 11:23 am

I read about a fund that pays back some part of the management fees if the target was not meet.

Could be an idea.

TSWP · Post by **TSWP** » Thu Sep 17, 2015 11:34 am

> I read about a fund that pays back some part of the management fees if the target was not meet. Could be an idea.

That seems a fair and innovative approach, thank you for bringing this to the discussion. Any additional info on them would be interesting.

svisstack · Post by **svisstack** » Thu Sep 17, 2015 1:15 pm

TSWP: everything you said i think is correct, but I just simply disagree.

bcs you have business failure already when you cant generate stable returns over time, otherwise if you can and you are sure about that then why dont try take 50% w/capped loss instead of 20% of performance fee, investor dont have this inteligence informations about your "know-how" and even if he will have that, he will not understand that and didnt know how awesome or fucked up this is what you created

also part of business risk and entrepreneur risk involves money already, so your understanding of things didn't change much, just your business inside is more complicated in matter of finance and risk taken, but if you will do that properly it can bring revenue that is out of reach for competitors.

TSWP · Post by **TSWP** » Thu Sep 17, 2015 3:27 pm

svisstack,

I am just saying that I don't think that type of liability imposed on the manager is fair. Returning a portion of management fees could be acceptable, it's like getting an advance on the job and you return it if you don't deliver as promised. But you can't ask the manager to pay for investment losses (unless there was some criminal action or fraud), for a number of obvious reasons.

goldorak · Post by **goldorak** » Thu Sep 17, 2015 4:40 pm

Come on 2% of assets is NOTHING to pay for hedge fund type management.

2% of an enormous investment, let's say 30mio$, is 600k USD. I defy you, institutional investor with all of your great "knowledge" to go and build the same kind of blackbox (as you like calling it) for such a low annual cost.

So if you think I am too expensive for you and my blackbox so easy to build, why don't you take your pink tie out of my office beach now? Actually, why did you come here in the first place?

TSWP · Post by **TSWP** » Thu Sep 17, 2015 5:06 pm

>I defy you, institutional investor with all of your great "knowledge" to go and build the same kind of blackbox (as you like calling it) for such a low annual cost.

Exactly my point.

HitmanH · Post by **HitmanH** » Thu Sep 17, 2015 5:56 pm

>> Come on 2% of assets is NOTHING to pay for hedge fund type management.

The problem is that every single fund - from research heavy - to less so - all now thing they deserve 2pc management fee. They don't.

TSWP · Post by **TSWP** » Thu Sep 17, 2015 6:58 pm

I have been researching fixed annual fees for a while, there seem to be a quite wide spectrum, sometimes overlapping between hedge funds and mutual funds: the Vanguard 500 Index used to cost you less than 0.2% a year (expense ratio) but there are some mutual funds that charge an expense ratio (yearly) of 1.5% or more, which is somehow hard to reconcile with the idea that a hedge fund charges the same, one of the two must be wrong, or otherwise the investor is wrong in paying that fee to both as they are very different items. The spectrum limit is marked by some hedge funds charging a 5% fixed yearly fee (you know who).

It would be interesting to see WHY each of these very different funds charges this or that fixed fee %.

Here is an additional interesting bit: Bruce Berkowitz of Fairholme Funds charges around ~1% yearly fee but to discourage speculators from short-term trading in The Fairholme Fund and The Fairholme Allocation Fund, they charge a 2% redemption fee if shares in these Funds are redeemed within 60 days of initial purchase. This made me wonder if one could offer hedge fund investors a progressively lower fixed yearly fee - if they stay with the manager for several years - like a sort of fidelity prize where the investor gets something back in change of helping the manager building the business by staying invested for the long-term. The fee curve must probably become flat after one point but overall it could provide a considerable discount to long-term clients.

goldorak · Post by **goldorak** » Thu Sep 17, 2015 7:26 pm

> The problem is that every single fund - from research heavy - to less so - all now thing they deserve 2pc management fee. They don't.

The problem are the investors who think that because they are unable to tell the difference between the two, then they should get a discount from all of them. Don't you think?