25% After the First 6%
Anyone know of any funds that currently run with this fee structure? I know Mohnish Pabrai copied it from Buffett's original partnership. It seems like a good structure for start-up funds that are well capitalized enough to survive a down year or two. It gives you two solid selling points of 1) your clients don't pay a dime until they get 6% and 2) you can run with a whole trying to replicate the original Buffett partnership approach (good selling poinr for small-cap value funds).
This would probably be a much better fit for a long-biased funds though. Cash is not a good benchmark when you need to earn more than 6% to make any money.
What's the point of running a hedge fund if you don't make money? I get what you're saying from a raising funds perspective- in theory it would be easier, but the benefit just doesnt outweigh working for no fee to me. Additionally, if the other guys are able to raise capital and get a fee + carried interest and you arent... what does that say about you as a manager vs them?
I prospected 100+ different funds during an internship and not a single one had this structure. All of them had some variation of 2/20. The biggest variations were the hurdle rates (6-8%) then catch-up, the management fees (1.5-2.5%) and incentive fees (15-25%). I guess my point is that its a very uncommon structure.
I know of one very successful fund that charged 3/30 with a 6% hurdle while it ran outside money.
If I was going to start out on my own down the line I think something along the lines of 1% mgmt fee with 25% incentive over 6% hurdle with a highwater mark (at the investor level, not the fund level) would be a good balance of aligned incentives, sustainable economics for the GP, and attractive terms for LPs.
The reason we charge management fees is because we work our asses off and deserve to be paid for that aspect alone. Above poster is right, it's a signal that your work quality is worth getting paid. Herd mentality is huge among LPs and so is the "you get what you pay for" mindset. One LP in particular was bashing on a fund charging 1% because he thought that was a signal that the PM was second tier. Obviously not true at all but it's human psychology.
Mgmt fees are also required in long-term focused funds (3-5 year outlook) because I may make you 0% returns in year 1 and make you 40% in year 2 utilizing the same process & investment approach. I need to eat and live comfortably for both years though to work intelligently to produce those results.
I structure my carry in a similar way in a long-only strategy that tends to quite high returns. Hurdle rate, no catch up, >20% carry above the hurdle rate. Although I could charge a catch-up, it is hard for me to intellectually justify given that I would effectively be charging fees for delivering a return which could have been more easily achieved by investing in corporate credit. I do take other fees, including management fees, which keep the lights on, but the real wealth creation in this strategy comes from delivering high rates of return to investors.
As a general comment on the various above "you get what you pay for type posts," it is absolutely true that the pension fund managers and consultants would rather pay $500 instead of $250 for the same penny loafers. Let's not lose sight of the fact that this is because they're stupid, not because the higher price is indicative of a better distribution of outcomes; in fact, the opposite is almost always true.
But let's also not lose sight of the fact that to the extent we're talking about some whipper snappers going out and cobbling together 5, 10, 25, 50, or even 100 million really aren't going to be subject to the trade winds generated by the consultants and other idiots allocating society's capital as dumbly as they possibly can. At that size, you're talking to family offices, HNW individuals, some fund of funds, etc. If they cut you a check it's because they don't care what Cambridge Associates thinks. And they are sensitive to fees. This structure can work in that setting.
I'm surprised more funds don't charge declining fee structures for clients that have been there longer. It will probably make clients more obligated to stick with you because they had to wait so many years to get their current fee structure.
Maybe something along the lines of:
Year 1: 25% of the profit Year 2: 25% of the profit after the first 1% Year 3: 25% of the profit after the first 2% Year 4: 25% of the profit after the first 3% Year 5: 25% of the profit after the first 4% Year 6: 25% of the profit after the first 5% Year 7: 25% of the profit after the first 6%
In my opinion the argument for not charging management fees is that a HF manager should be able to save enough during good years to still pay his employees market wages during down years, even if it comes out of his own pocket.
And RLC1 hit the nail on the head for this fee structure. I was day dreaming about setting up shop in Naples and pitching the 25% after the first 6% to old rich people. Plus no state capital gains tax on carried interest and working on the beach sounds dope. I see what Brett Icahn is up to.
Edit: I may want to accelerate my declining fee structure if I am working with old people.
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