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TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-16 18:34
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?

"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: 381
Joined: May 2012
 
Posted: 2015-09-17 00:22
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.





"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: 2015-09-17 02:12
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!

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

goldorak


Total Posts: 1000
Joined: Nov 2004
 
Posted: 2015-09-17 08:10
> 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.

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

Scotty


Total Posts: 721
Joined: Jun 2004
 
Posted: 2015-09-17 09:45
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.

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

TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-17 10:23
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.

"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

Baltazar


Total Posts: 1763
Joined: Jul 2004
 
Posted: 2015-09-17 11:23
I read about a fund that pays back some part of the management fees if the target was not meet.
Could be an idea.

Qui fait le malin tombe dans le ravin

TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-17 11:34
> 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.

"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: 2015-09-17 13:15
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.

Time well wasted.

TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-17 15:27
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.



"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: 1000
Joined: Nov 2004
 
Posted: 2015-09-17 16:40
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?




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

TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-17 17:06
>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.

"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: 436
Joined: Apr 2005
 
Posted: 2015-09-17 17:56
>> 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


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-17 18:58
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.


"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: 1000
Joined: Nov 2004
 
Posted: 2015-09-17 19:26
> 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?

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

Scotty


Total Posts: 721
Joined: Jun 2004
 
Posted: 2015-09-18 00:21
You're right goldorak. 2% on $30m would be about right. However, 2% on $30b is $600m.

Management fees are supposed to take away the short-term existential pressure so the manager can focus on performance.

Mechanically management costs will have a fixed and a variable component. So I don't think a simple linear in AUM formula is right. Surely they should at least scale down somehow with larger AUM? The extension of that is to transparently build the costs into the fund return so the manager is fully focused on performance (however defined).

It's an alignment issue.

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

goldorak


Total Posts: 1000
Joined: Nov 2004
 
Posted: 2015-09-18 08:28
Most hedge funds have a size below 200mio$ and everybody thinks they should behave like a hedge fund managing 30b$... Confused

To come back to my example. This was one investor coming with 30mio$. Your example with 30b$ means lots of investors would have pooled their monies and come all together. I agree that 600mio$ would be a nive budget for a quant research team BUT they would need to be ready to pool their research/management too. They never will. Unfortunately for them they are just too happy to reinvent the wheel for themselves.

A hedge fund is not a charity business. An investor telling me I should reduce my fees because I am managing lots of monies would get the following answer: why don't you buy a share of my management company to receive that wonderful stream of dividends which would greatly compensate for the fees?

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

TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-18 11:07
I think both goldorak and Scotty have a point.

I agree with goldorak that an investor must recognize the value that a manager has put in his company in terms of work, research, models, software for algorithmic trading, infrastructure, I mean all this stuff take years and hundreds of thousands of dollars to build, there is a hurdle to get into this business and that is part of it, otherwise any moron can code up something from his bedroom and become a billionaire in no time.

However, I also agree with Scotty (and this was in part the focus of this thread when I started it), that there is misalignment between the size of fixed fees and operation costs.

Proof in case: I have visited a US fund that had 50B AUM, 2/20 scheme, they make 2 Billions a year just to turn on the lights on January 1st and they have a 100 people team, and operate a low-tech automated trading operation mostly based on rebalancing portfolio mix through a mathematical formula written in the 80s, they have no traders and is mostly a cargo-ship operation on auto-pilot with offices in a building outside of town. I do not know precisely their operating costs, but I think they are MUCH smaller than 2 billions USD a year.

I like this bit from Scotty, for fixed fees, somehow there should be a re-adjustment in that sense, 2% or even 5% is OK if you have a very small AUM, but when you grow in theory you could need much less, like 1% or even less:
"I don't think a simple linear in AUM formula is right. Surely they should at least scale down somehow with larger AUM? The extension of that is to transparently build the costs into the fund return..."

"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: 381
Joined: May 2012
 
Posted: 2015-09-18 11:10
btw, I apologize for being so obnoxiously present in this thread, is just that I really want to come up with an innovative fee structure and I am taking the occasion to brainstorm with you guys.

thanks for participating in this discussion.

"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

AndyM


Total Posts: 2321
Joined: Mar 2004
 
Posted: 2015-09-18 11:42
Thousands and thousands of funds launch every year with the same fee structure, tweaked as appropriate. The other side is pretty sparse.

What does this tell you? The industry is crying out for innovation? Or the industry has a hugely strong status quo bias?

There's no upside for allocators in backing mavericks. Better to fail conventionally than succeed unconventionally, etc.

This is a good way to get nowhere in my opinion. You will be sending all the wrong signals. After you've run a multi-billion $$ fund and become a known quantity, you can start proposing some more innovative structures and see if anyone bites.

I used to be disgusted; now I try to be amused...

goldorak


Total Posts: 1000
Joined: Nov 2004
 
Posted: 2015-09-18 13:58
@TSWP: Where is it written that fixed fees are here to pay for operation costs?


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

NeroTulip


Total Posts: 997
Joined: May 2004
 
Posted: 2015-09-18 14:31
It is not unheard of for funds to charge operating costs (including traders' bonuses) to investors, Millennium and Citadel do this IIRC. Whether this is a good deal for investors is debatable.

Alignment of interests is usually demonstrated by the manager having a large part of his net worth invested in the fund i.e. "eating your own cooking". If the manager does not have significant assets to invest in the fund, what does it say about his ability to make money? I would find it hard to trust someone to invest my money if they hadn't made a few million for themselves before, and were not putting at least half of it in the fund. At the other end of the scale, you have to think hard about the incentives of a manager who is worth several billion and/or has only a fraction of his net worth in the fund and/or manages several funds with different strategies...

Inflatable trader

TSWP


Total Posts: 381
Joined: May 2012
 
Posted: 2015-09-18 14:44
goldorak:
we can debate what "operations costs" means, what it includes, maybe there is a better word for it, but in the end of the day, if you charge me a x% fixed fee a year on all my AUM with you, if it is not tied to your performance, then it means is tied to your "running costs" (whatever that may mean... your cutting edge infrastructure, your genius quant team, or your chalet in Zermatt...).

"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: 381
Joined: May 2012
 
Posted: 2015-09-18 15:38
I have read somewhere that a certain Professor at Cass University in London has simulated the performance of thousands of fund managers using a benchmark return matched to the UK’s FTSE 100. They calculated the average financial well-being of investors and fund managers for manager performance under three different fee structures.

This is the result: “There is no single structure that simultaneously maximises both the investors’ and the managers’ satisfaction. In fact, our results show that the most prevalent fee structure currently in the UK market (a fixed fee as a proportion of AUM) is generally the best structure for the manager and the worst for the investor!

From the information I am gathering from insiders and from various papers, it seems investors are not necessarily so happy with the status quo, so maybe being a bit "innovative" (at least on the fixed fee front) may help to conquer and retain clients, I think I am not the only one that has heard about 1/15 fees becoming quite common.

I have spent tens of thousands of hours to develop my own research and software, why should I not spend some time to see if I can offer a better fee structure since it is a key part of the business?

And just to be clear: I am more than happy to go to investors and ask 2/20 but I'd be surprised if someone walks away because I charge them a 1/20...

"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: 381
Joined: May 2012
 
Posted: 2015-09-18 16:01
If I was an investor, let’s say I have 35 years to retirement and $1M to invest. Assume the base amount earns 6% annually. If advisor fees reduce returns by only 0.25% a year, then the base amount will increase to $6.6M over that time frame.

However, if advisor fees reduce returns by 1.25% a year, the base amount invested will grow to only $4.8M— quite a difference: the 1.25% fee will cost me about $1.8M more.

I think the discussion of the fee is not trivial, it does make a big difference to the investor, although (as AndyM pointed out) most investors so far have been OK with the status quo. Is it going to be like that forever? Personally, I doubt it.

I may be wrong.

"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
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