Traditionally the hedge fund industry has worked on dual fees, the management fees and the performance fees. Here, we would like to discuss the first of the two, the management fees, and why it is a practice?
The often cited and very logical reason, which can be accepted at face value is, the “management fees” is used to pay for the management of fund, the back-offices, the various services hired by the fund to make it successful, or to rather keep it functioning.
In the absence of gains or profits while engaging in the activities, as mandated in the fund’s charter; the management fees is still paid out to the hedge fund management and general partners. This would often include salaries for everyone involved in running the fund. Obviously due to non-performance of fund within a time duration, does not mean that management failed to discharge it’s duties prudentially and that was the cause of non-performance. In such a case, if the “management fees” is withdrawn, then it means penalising the management team, which they can argue, is none of their fault.
To much extent, the above is true. What we are trying to point is another aspect, which is not looked.
“Management fees” charged by hedge funds acts as a safety net. It is just like, “Heads I win, Tails you lose”.
If the funds perform, I get a nice large share of profits, but if the fund fails to perform, the management is not really at peril, because they at least have their “management fees” to fall back on and save their skin.
Hedge fund managers can very well argue that it is their money also parked in the fund, and hence the non-performance of the fund hits them as hard as limited partners. While this is true, but clearly the limited partners are at a disadvantage.
The argument of mismatch between the rewards for a general partner and limited partners in a hedge fund is long, and often quoted practise is to lower the management fees. Some guys have gone down from 2/20 to may be 1/20; but the lure of safety net is not gone.
Fundamental thing is that money given by limited partners to the fund, brings huge amount of leverage, which would have been otherwise not been available to the general partners, if they would have been trading with their limited money alone; and hence their profits would also have been far less.
Limited partners with their money, bring leverage and thus in absolute terms far higher returns for general partners.
If trading alone with their own money would have been so profitable and fruitful,none of them would have become hedge fund managers, but would have been just traders, trading with their own money. The very basic fact that they chose to forego being a trader with their own money and become hedge fund managers, proves the amount of leverage LPs bring to table.
And in spite of this then, “management fees” is charged by the fund management. Thus it is so much lucrative to be a hedge fund manager, rather than just trade with your own money. You have a fixed income, irrespective of outcome of the fund,and when you do good, you really do good!
There have been few funds who have focussed on bringing this parity and thus linking the management’s fees only to the fund’s performance, but there have been those who can be counted on fingers.
149 Research aims to be one such hedge fund firm, which would not charge the management fees from it’s partners. We intend to eat our own dog-food, good or bad. Work without any safety net, knowing very well, that one wrong step could jeopardise the smooth functioning of the fund, would keep us grounded and rational, while focussing on the mandate and charter only.
Devoid of safety net, we really aim to be a hedge fund in the traditional sense, hedging the investment risks, because we know that we survive only if the outcome delivered by fund’s activities is positive in the sense. We thus, do not give in to any irrational exuberance displayed by the market, from time to time.
When we are playing with the book and being prudent, it also allows us to be really transparent about our activities v/s the our charter, with our LPs. Trust be gets trust, and we want to prove that. For a healthy long term client-management relationship, it is highly imperative, that we are transparent with our partners.
Working without management fees, makes us more accountable towards our LPs because, we become fully accountable to our own activities, as our very own survival and not mere profits or earnings matter on it.
149 Research, a transparent,prudent and accountable hedge fund firm, with no “management fees”.
For more information, please contact us.
149 Research 