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TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-08-13 16:28
I have recently read a paper that discusses the various impacts of the frequency used by funds to set the new watermark and consequently calculate their fees. Part of my interest in this topic derives from the fact that I am trying to launch my own first fund and thus I am wondering about the best possible fees structure to propose to prospects (5/44 like RenTec, I know, if just one was RenTec...).

Seriously, here is the paper link:
Crystallization – the Hidden Dimension of Hedge Funds' Fee Structure
(I also have a version with the tables and figures, .pdf format, email me privately and I can forward it to you).

The curiosity I have, my question, is this:
has any of you made any study about the different returns that you could achieve varying the crystallization frequency, for example charging incentive fees to investors every month vs. quarterly vs. yearly?

Which frequency do you find more convenient for both you and the investor? (assuming you care about both).

Do you find investors may be put off by a monthly fee as it would seem too frequent and possibly skewed in the fund's favor by capturing short-term returns as soon as possible to cash in before the inevitable drawdowns?

If you are willing to share any thoughts, or comment the attached paper it would be great.
Thank you.

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

goldorak


Total Posts: 986
Joined: Nov 2004
 
Posted: 2015-08-13 16:40
The higher the performance the higher the frequency incentive fees should be crystallized. Otherwise what is the incentive to take risk the last 6 months of the year?


If you are not living on the edge you are taking up too much space.

goldorak


Total Posts: 986
Joined: Nov 2004
 
Posted: 2015-08-13 19:23
Actually I forgot to mention one thing. The incentive for managers is to have their incentive fees as long as possible too.

As long as you have uncrystallized accrued incentive fees, your volatility is artificially reduced by the percentage of incentive fees (often 20%). That makes you look so much better from a sharpe ratio perspective... Chew

If you are not living on the edge you are taking up too much space.

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-08-13 20:05
> Otherwise what is the incentive to take risk the last 6 months of the year?

Yes, that is what I have thought.

I wonder if investors would accept a variable frequency crystallization scheme based on performance, probably not.

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-08-13 20:09
> As long as you have uncrystallized accrued incentive fees, your volatility is artificially reduced by the percentage of incentive fees (often 20%). That makes you look so much better from a sharpe ratio perspective...

Good thought, so the goal could be to figure out a fee structure that varies the frequency of the crystallization but tweaked to optimize the look of the Sharpe Ratio Cool

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

goldorak


Total Posts: 986
Joined: Nov 2004
 
Posted: 2015-08-13 21:24
Well my personal preference in term of performance fee would be the following.

Take a fixed horizon, let's say 3 years. Investors are locked-in over the period. You define a minimal amount that needs to be paid in order for you to run your business.

Now the deal is you take 100% of the returns above a performance of 50% on the interval, nothing except the small fee if you do under 50%.

After three years, counters back to zero and start for a new period.

This would solve so many problems: staff fidelity/compensation, HF/investor incentives, HF/investor goals, and of course sales relationships, reporting and any other a* licking activities.

If you are not living on the edge you are taking up too much space.

FDAXHunter
Founding Member

Total Posts: 8349
Joined: Mar 2004
 
Posted: 2015-08-14 05:03
Goldorak's proposal is fraught with so many problems and dangers, I don't even know where to start.... So I'm thinking he must be just joking.

The Figs Protocol.

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-08-14 10:50
I think the sense of my question in this thread was more along these lines:

has anyone tried FOR REAL a "smaller than QUARTERLY" crystallization frequency and what are the findings? is it better or worse and why...

The study mentioned above finds that most managers use QUARTERLY fees structure, at least on the sample studied, otherwise it's usually YEARLY. I wonder if MONTHLY or BI-MONTHLY has any advantage in practice, not in theory, if anyone had tried it and what was their experience with that.

Or alternatively: have you studied the issue and what are your conclusions, why did you choose to use quarterly vs. yearly or...?

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

svisstack


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-08-14 11:28
>> You define a minimal amount that needs to be paid in order for you to run your business.

how you can estimate that on longer term than 6 months?

Time well wasted.

goldorak


Total Posts: 986
Joined: Nov 2004
 
Posted: 2015-08-14 14:21
@FDAXHunter: I am not joking at all, and you will have noticed the word "my personal preference" at the very beginning.

But I would love hearing from you what problems would exist in my solution that does not exist in the standard "I take my incentive fee out every year or every quarter".

If you are not living on the edge you are taking up too much space.

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-09-03 12:24
Picking up again this thread, what would any of you say, if you were an investor, if your manager would apply you some sort of profit fee based on "merit" ?

Example:
if your fund as a whole in a year returns 0% to any % that is equal to the current average of the returns of some sovereign bonds out there (say a mix of US, German and UK bonds), you charge no profit fee, only a flat management fee (say 2%)

if your fund as a whole in a year returns 5% to 10% you charge a 20% profit fee + management fee

if your fund as a whole in a year returns 10% to 20% you charge a 25% profit fee + management fee

if your fund as a whole in a year returns 20% to 30% you charge a 30% profit fee + management fee

if your fund as a whole in a year returns 30% to 40% you charge a 40% profit fee + management fee

if your fund as a whole in a year returns => 40% you charge a 50% profit fee + management fee

The profit fee numbers I have presented must be elaborated more precisely, this is just a dummy to give the idea: the larger the return made by the fund, the larger the profit fee but if the profits are below a certain sovereign bond-comparable yearly returns threshold we charge no profit fees to the investor.

Management fee is always charged because it's a way to guarantee to the investor that we can always run the business. We can put a cap on the management fee based on actual expenses, so it does not become a way to make money no matter what the performance is, at the expenses of the investor (that is how it is now, and has been for a long time).

I am trying to align the manager's interest with the investor's interest, as much as that is possible, we know they may be diverging.

Thoughts welcome.

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

HitmanH


Total Posts: 427
Joined: Apr 2005
 
Posted: 2015-09-03 14:55
Returns encourage you to punt.
There are some US shops out there I know who run managed accounts - and they pay a fee which increases as realised Sharpe does.

svisstack


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-09-03 15:22
better one year good return then 2 years half of it.

Time well wasted.

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-09-03 16:24
>Returns encourage you to punt.

Do you mean the investor may not like the idea that you could take more risk than usual to generate larger returns (to create a larger profit fee for yourself)?


"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

deeds


Total Posts: 347
Joined: Dec 2008
 
Posted: 2015-09-03 16:28
svisstack - better for who?

taking risk doesn't usually decompose so simply as a choice between one big bet or two smaller bets whose sum is equivalent

don't returns need to be considered in the context of risk?

svisstack


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-09-03 17:01
@deeds:

yes i know it ;-) i just pushed first thought about this fee schedule setup, dont know anything about his underlying business

his goal is maximize profit from performance fee at the end of the year,
just pointing out that can be possibility to adjust trading behavior by using:
- time to end of the period
- current ytd return generated
- fee schedule structure (performance fee jump points)
- internal knowledge about trading model adjusting possibility

don't know that it can be worth spending time on it, maybe yes maybe not,
it look like incentive to be more volatile at the end of period while being close to performance fee jump point.

and of course its good for investor also because profit fee rate going up with return,
probably investor intention is to maximize total return not drawdown or something else i just dont think about this much

Time well wasted.

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-09-03 17:05
>There are some US shops out there I know who run managed accounts - and they pay a fee which increases as realised Sharpe does.

Thanks for the valuable input, so they consider Sharpe Ratio as a better proxy to determine the manager's returns vs risk taken.

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-09-03 17:19
svisstack,
to answer your questions:
the reason why I started this thread was to figure out where one could improve the current fees structure, for both investor AND manager

let's say we have 2/20, on average (some say 1.5/15 today, and RenTec is at 5/44).

2% management fee for a 10M fund or a 50B fund it's not the same, as probably the 50B firm does not need all that money to assure smooth running of the business (I know at least 1 50B fund that has a policy to employ <=2 people per 1B AUM, do they need 1B USD/year to run a 100 people business that earn on average a few hundreds K each/year? 50% of that management fee, 500M USD, goes straight in the pockets of the owner of the fund with no benefit for the investor, while a 10M fund is probably struggling to survive with a 200k USD/year management fee)

20% profit fee is a one-size-fits-all, good for the manager sometimes, good for the investor sometimes

it may be worth thinking a different approach, meritocratic or something else, just brainstorming here... input parameters to work on can be crystallization periods, Sharpe Ratio-based meritocracy, returns incentives, else, etc.


"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

HitmanH


Total Posts: 427
Joined: Apr 2005
 
Posted: 2015-09-03 18:57
One other statement (unfortunately) is that if if you're proposing to launch a fund with these fees - beware that LOTS of investors don't like what they are not used to.

If the analyst likes you - but has to explain your wierd fee structure to his investment committiee - it isn't good. Even if there are benefits / protections for the manager - it's not worth the hassle...

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-09-03 19:13
> beware that LOTS of investors don't like what they are not used to.

Yes, I have heard that from a chairman of a multi-B fund. He told me: is better to go with a 2/20, classic fee, no hassles, do not disrupt the status quo, you have nothing to gain from this sort of "fee innovation".


Right now I am elaborating something based in part on comments made by you and goldorak, plus some other ideas I have. If is worth it, when ready, I will post it here, I am thinking something in the multi-year crystallization space, delaying profit fee charges on the years where you underperform the benchmark, with 1-year lock ups and 1-year performance sampling periods, recalculating fee for the whole period from last watermark where you outperformed, but obviously what you just said makes me feel that it may not be a good idea as it will be too complicated to understand for the investor...

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

svisstack


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-09-03 19:27
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

Time well wasted.

Tradenator


Total Posts: 1582
Joined: Sep 2006
 
Posted: 2015-09-03 20:14
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


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-09-03 20:36
>> 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.

Time well wasted.

TSWP


Total Posts: 367
Joined: May 2012
 
Posted: 2015-09-04 11:15
>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.

"I couldn’t write programs […] I wouldn’t have done well in an Olympiad or a math contest. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach." - Jim Simons

Scotty


Total Posts: 721
Joined: Jun 2004
 
Posted: 2015-09-16 17:03
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.


“Whatever you do, or dream you can, begin it. Boldness has genius and power and magic in it.”
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