Economics of pass through MM
I've been at MM for close to 5 years now, and I've never gotten a straight answer as to how pass through fees work. Some people say the pod bonus comes from the 20% incentive fee, others say it is baked into the pass through fee, and some say it is a blend. So let's do a thought experiment.
Assume I have a fund with 100 dollars and charge pass through fees. I make 15% this year. Let's just assume conservatively that base expenses e.g. salaries, Bloombergs, office space comes out to $3 (3% fee). Now the question is how do I pay my PMs who have made money.
Now if all of the PMs are positive then this question is straightforward. Each PM makes 20% of his PnL which comes out to 20% of 15% -> $3 allocated to PM bonuses.
The more likely scenario is that some PMs are down and some are up and the firm has to bear out the netting risk. Now let's say the up PMs made $25 and the down PMs lost $15. That means that you need to allocate 20% of 25% as bonuses which comes out to $5.
I guess I have answered my question because it seems like in a reasonable year the bonus ($5) and the baseline fees ($3) would both come out as part of the pass through fee and the 20% incentive would be the cherry on top for management. Seems reasonable but curious if anyone had a better idea of what actually goes on.
Thats not right. Management doesn't get 20%
Edit: not going to explain the nuance.
Please explain how the economics work then
It is exactly how you laid it out. And yes, people like KG and Izzy do get 20% all to themselves.
The owners of the MM Fund (Ken at Citadel, Izzy at Millenium get 20% of the trading P&L (this is the "performance fee to investors").
Separately, the Pod PMs get 15-18% of their Pod P&L, to be distributed to themselves and all their employees (analysts, etc...)
However, the source of that 15-18% that's given to the PM does not come from the 20% that Ken and Izzy get...that is charged (passed thru) to the typical 2% AUM Mgmt fee directly to LP investors (in the case of Millenium and Citadel, that 2% fee is more like 5-6% of AUM).
So, after both that 5-6% AUM mgmt fee (pays for all employees, PMs + analysts salary and bonus+ all tech+infrastructure costs) and the 20% performance fee to the owner of the business (Izzy / Ken), fund investors tend to net, on avg around 8% a year (this varies of course).
6% a year seems low right? MLP is known to net around 13-14% annually since inception. Unless those numbers are pre pass through fee (doubt it)?
some MM funds like Millenium and Citadel do better than 6%...some do worse...i was just throwing out a number, hence the "this varies of course"
I think the part about the pod P&L not coming from the fund's 20% performance fee is correct. That is what the term "pass-through" imply. Other parts are a bit different from what I know.
Pods receives a certain management fee that is a function of their book size. This budget covers the base salary for the team and other costs (infra costs, office and desk space etc). The costs are charged by the MM and paid back to them. The performance fees for the pods are a percentage of their PnL after deducting any excess costs not covered by the budget for the pod.
The pass-through model typically results in around a 30-3 costs for their investors.
When PMs start out at MM, people here mention they get ~100M to work with, or ~5M risk. Is this before leverage? There was also some talk of Citadel PMs getting 1B - that has to be after leverage right?
100mm allocated to each pod is pre-leverage
My understanding is that leverage is done at the fund level, the chunk of the book (i.e the 100M) that a pod gets to start with comes from the post-leveraged amount.
How do these funds get away with 5% management fees? just curious because everyone always talks about fee compression so pretty interesting that LP's are willing to pay up. Do you think this is sustainable or how does it compare against top PE funds?
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