Incentive/Profit Fees Crystallization Frequency

svisstack · Post by **svisstack** » Thu Sep 03, 2015 7:27 pm

honest fee structure is:

- management fee equal to 50% of real costs (equal split with investor)

- 50% performance fee above inflation and 0% participation in loss

- 100% performance fee crawlback

investor gives money, so he don't need to make anything related to fund,

you making magic combined with secret sauce, so you don't need to take 100% from loss.

seems equal

if you are getting some credit from investor related to trust in you bcs you dont have track,

so in this case you should take some % of first loss.

for example people will start using this model, to get investors attention they will be lowering fees rates to point where it will be still profitable for them to run this business, and you will probably end on something like 2/20 or maybe higher when you are outperforming market

also think it can be not worth it

Tradenator · Post by **Tradenator** » Thu Sep 03, 2015 8:14 pm

Don't forget about introducer kickbacks and fee rebates. If you want to grow you need to be commercial about it. I wouldn't take svisstack's input too seriously here, it's more noise than signal for your purposes.

svisstack · Post by **svisstack** » Thu Sep 03, 2015 8:36 pm

>> If you want to grow you need to be commercial about it. I wouldn't take svisstack's input too seriously here, it's more noise than signal for your purposes.

Totally agree.

TSWP · Post by **TSWP** » Fri Sep 04, 2015 11:15 am

>Don't forget about introducer kickbacks and fee rebates. If you want to grow you need to be commercial about it.

Sure, that must be computed as well. I'd like to hear your thoughts on fee rebates.

Scotty · Post by **Scotty** » Wed Sep 16, 2015 5:03 pm

I like this idea of being innovative in the fee structure. I think it is about time hedge funds looked into this in order to build better alignment with their investors. However, as noted, your investor universe will not include those confused by something that isn't 2/20 or 1.5/15. But maybe you don't want those investors anyway.

On the management fees, a 2% fee seems to inevitably encourage an asset gathering risk avoidance mentality. Once the fund size is big enough the principals will merely want to build AUM and harvest the management fee. They are likely to actively avoid taking much risk as it increases the chance of draw downs and withdrawal of capital. Further, the bigger the AUM the more market impact and the harder it is to generate returns regardless of intentions.

What we are doing is having no management fee and incorporating the costs directly and transparently into performance. The performance fee is then worked out on a net profits basis.

In terms of frequency, it really should depend on the liquidity / turnover of the strategies you are running. Again, to be aligned you want to be paying on realised profits. Macro trading - yearly. Short term exchange traded - quarterly or even monthly.

Finally, on the performance fee, we want to share both the upside and the downside (with respect to the benchmark) of the strategy with the investor. Heretical I know, but it is the alignment thing yet again.

TSWP · Post by **TSWP** » Wed Sep 16, 2015 6:34 pm

Scotty, thanks for your input, I have a couple of questions:

>In terms of frequency, it really should depend on the liquidity / turnover of the strategies you are running. [...] Macro trading - yearly. Short term exchange traded - quarterly or even monthly.

I am in the short term trading space (say seconds/minutes to a few days, couple weeks max, usually), purely quantitative, no macro, so you would suggest a quarterly or monthly crystallization in this case? Is good for the manager, but not very favorable to the investor, it may increase considerably profit fees by year end.

>Finally, on the performance fee, we want to share both the upside and the downside (with respect to the benchmark) of the strategy with the investor.

Can you clarify what you mean with "share" the downside?

TSWP · Post by **TSWP** » Thu Sep 17, 2015 12:22 am

I have been reflecting on the reduction of management fees but I am not so sure that it would make the manager look more appealing, it may be an unnecessary cut.

The profit fee is the area where I think we could be more creative:

- the crystallization frequency should not have less than a quarterly time period, otherwise only the manager benefits, and probably I would choose a longer frequency, like 1-year, it's more fair to the investor.

- I'd be curious to hear expert opinion about this: a 50% incentive fee applied only to the portion of the returns that beats the benchmark, for example if 1 Million USD invested buy&hold in the SPY returns 100,000 USD after 1 year (with crystallization and lock-up = 1 year), while 1 Million USD invested with a manager that actively trades the SPY returns 200,000 USD, this SPY manager applies a 50% fee on the outperformance, i.e. (200k-100k)/2=50k. So the manager gets 50% of the outperformance, as described, but nothing on the portion of the returns that are <= benchmark.

Scotty · Post by **Scotty** » Thu Sep 17, 2015 2:12 am

In short, I think it has to come down to whether you view your investors as customers and you want to look after them and be aligned with them and create value with them. Or whether you just want to transfer value from investors to you.

Personally, I think a flat management fee is a pretty blunt tool and prone to misalignment. There are some big funds out there whose business is predicated on generating just enough performance and no drawdowns so as to grow AUM. This is supported by an institutional investor environment that wants job safety and so only puts money with large established managers.

On frequency, if you are making and realizing profits monthly without some hidden risk exposure, then you could distribute profits more frequently. Some investors may like a more frequent cash flow stream, albeit their returns become arithmetic rather than geometric.

On performance, it depends on you return profile, but essentially, the standard is the manager receives 20% of the upside and none of the downside. If you had confidence in your ability to generate returns for your client, could you not signal that by offering to share the upside and downside with the client 50/50? Some technicalities in exactly how this is done!

goldorak · Post by **goldorak** » Thu Sep 17, 2015 8:10 am

> If you had confidence in your ability to generate returns for your client, could you not signal that by offering to share the upside and downside with the client 50/50? Some technicalities in exactly how this is done!

Lucky you bankruptcy laws exist.

Scotty · Post by **Scotty** » Thu Sep 17, 2015 9:45 am

Yes sure. You would likely want to limit your exposure in some way or retain a proportion of earlier profits as the future downside exposure. I'm just suggesting that there is some logic in providing a more symmetric payoff structure in the performance component.