Most Liberty Blitzkrieg readers will be familiar with the common fee structure for hedge funds known as ’2 and 20.’ What this simply refers to is the fact that a manager will take as a fee 2% of the assets under management, as well as 20% of the profits (above a high-water mark). While many people would balk at giving up such a high percent of profits, when the industry first got going several decades ago the managers were so few and the returns so huge, that high net worth individuals were happy to pay up for alpha.
Fast forward several decades, and the hedge fund industry is extremely crowded and competitive. What’s worse, in such a central bank manipulated market, it has become extraordinarily difficult for hedge funds to outperform and generate the desired ‘alpha.’ Nevertheless, people that go into this business generally go into it for one reason. To make a shit-ton of cash.
So in a world of poor performance, the hedge fund industry needs to earn more from the 2% and less from the 20%. In this reality, performance actually takes a backseat to assets under management. As long as you can get your assets under management high enough, you can earn hundreds of millions on fees alone. After all, 2% of $10 billion = $200 million per year in fees.
This post was published at Liberty Blitzkrieg on Thursday Oct 9, 2014.
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