Forums  > General  > Incentive/Profit Fees Crystallization Frequency  
     
Page 3 of 6Goto to page: 1, 2, 3, 4 ... 5, 6 Prev Next
Display using:  

dgn2


Total Posts: 2054
Joined: May 2004
 
Posted: 2015-09-18 16:12
I think that one might also consider your target investors. Family offices - for instance - might be much more interested in different structures than say other institutional investors.

...WARNING: I am an optimal f'er

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-18 18:28
> Family offices - for instance - might be much more interested in different structures than say other institutional investors.

Specifically with reference to Switzerland (where my company is located), in fact, I think that could be a path that may pay off.


Aside note: I appreciate that many of the best brains of the forum have chimed into this discussion to offer their valuable opinion. Thank you guys.

"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: 2015-09-18 20:01
Fixed fee is a payment to hold the right to access the system.

Otherwise I would have all the problems in the world justifying fees to cover my monthly 800$ expenditures. Party

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

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-19 10:35
>Fixed fee is a payment to hold the right to access the system.

I will make a summary of all the various proposals/angles that each of you has brought to the discussion, and I'll post it in this thread, so we'll have a panoramic view of all the various ideas/opinions on each part of the fee pricing mechanism.

"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: 383
Joined: May 2012
 
Posted: 2015-09-20 14:42
As promised, I am posting here a re-cap of all the contributions to this discussion, a sort of sum-up of everything we said so far:

*crystallization frequency is usually performed on a quarterly or annual basis; it’s hard to find a valid logic to trim the crystallization frequency to an interval that will balance well the manager and the investors interests: a high crystallization frequency usually favors the manager, while a low crystallization frequency usually favors the investors, as discussed in the paper linked at the start of this thread

* increasing crystallization frequency with the frequency of trading is a possible path, as long as risk-adjusted returns stay above the benchmark, otherwise is a "heads I win, tail you lose" scheme

* efforts to innovate the 2/20 typical fee structure may hurt the manager, institutional allocators may not like it, but it is becoming more common, as of lately, to hear 1.5/15 fee structures for new funds launching while the highest fees structure currently out there for established funds appears to be RenTec’s 5/44 (Medallion Fund)

* family offices may be more interested than institutional asset allocators in innovative fee structures; the same may apply also to private investors (U/HNWI)

* fixed management fee is seen by some as “operation costs” while others see it as a “entry ticket to access the manager’s talent”, however there is probably room to resize/review/adapt the fixed management fee as not all funds need/deserve to charge a 2% management fee to their clients; it would be actually good to find a method to quantify how much % a manager needs to charge to clients in fixed management fees

*according to some studies at Cass University, 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 so there is certainly room for improvement in the currently linear relationship between AUM and fixed management fee

*possible solutions to improve the fixed fee size could be to tie it to the funds yearly operating costs or to use some model to reduce the % charged as the AUM grows, or to offer progressively decreasing fixed fees through the years to clients that are staying for the long-term (a decreasing curve up to a certain point, then flat)

*some (very rare) funds may offer to pay back a part of the fixed management fee if the yearly profit target is not met

*on the incentive fees front: most funds charge a 20% profit fee, however some shops running managed accounts increase their profit fees when their Sharpe Ratio increase

*solutions to improve incentives fees: variable profit fees increasing with the size of returns, or otherwise charging a 50% fee only on the portion of the realized profits that beat the benchmark, or charging 100% of the returns above any performance => 50% on the selected crystallization frequency interval (e.g. yearly).



"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

RFMontraz
NP Italian Stallion

Total Posts: 2014
Joined: Mar 2004
 
Posted: 2015-09-23 16:22
I'm a bit surprised [and I must confess annoyed] to read this stuff...

- is there a need for an academic paper to figure out that high crystallization frequency (better yet, instant) favours the manager while low one (better no one) favours the investor?

- Is it possible to refrain from mentioning billions, Rentec, Simons, Griffin, billions again etc... when discussing start ups?

- Wouldn't it be better to stop talking in hypothetically unbiased terms of "what is better for the investor?" given that everybody here is/want to be the investment manager and - bottom line - cares or would/will care exclusively about what is better for him which is not necessarily in the interests of the investors?




What do the investors prefer? Low fees, low frequency highwatermark, instant redemptions, no gates.

What does the IM prefer? High fees, high frequency crystallization (even better: no HWM), locked-in capital, long notice periods for redemptions, gates.

What should you do? Simple. Depending on which category you belong to and who is your counterparty in the other, go for what you can get away with (the other side will worry about protecting his own interest, I guarantee you that).

As IM 2+20 seems the obvious choice. I doubt lowering fees in the name of "a world more just and equal" will win you more business (but I'm pretty sure you will make less money). Higher fees I think will get you nowhere.

This is not exactly lion and gazelle shit but there are more analogies than one cares to admit (even if we are all busy pretending otherwise).



HitmanH


Total Posts: 444
Joined: Apr 2005
 
Posted: 2015-09-23 17:23
Not always true - not go for what can get away with - as (espeically in say the CTA space) there is an arguement / tactic for going for lower fees - in a hope to amass more assets

RFMontraz
NP Italian Stallion

Total Posts: 2014
Joined: Mar 2004
 
Posted: 2015-09-23 18:02
I think fees higher than 2+20 will make it impossible for a common mortal to raise assets (in absence of a well placed best friend at a FoF/Asset Manager and a lucrative retrocession scheme). Differently from you I do not think that lower fees will help you raise more assets, certainly not in an FV ratio - i.e. half the fees, double the AUM (I mean people that decide to invest with you if you charge them 1+15 would most likely have invested if you charged 2+20 anyway) and can be a serious impediment in running the business (for example I think that charging no man fee and a higher performance fee, while a well meaning decision, is a TERRIBLE business decision for a fund manager).

The rest, no offence but - giving money back to investors, calculating fees on billions when Bloomberg dedicates articles for launches of 5-10M funds, discussing University papers that can only be relevant for an unbiased academic and not for practitioners with skin in the game etc.. - to me smacks a bit of a theological medieval debate....


TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-23 19:11
> I mean people that decide to invest with you if you charge them 1+15 would most likely have invested if you charged 2+20 anyway

Nobody argues with that.
What I am arguing with is that the industry uses a generic 2+20 one-size-fits-all but if I am an investor and I have to pay you a 20% fee during a year where you made me only a 2% return, I don't know about you, but I feel ripped off.

> to me smacks a bit of a theological medieval debate....

It's not theology, it's business. Can I improve my fee structure to attract investors in higher numbers and stay with me for longer terms? Is 2/20 the ideal formula to achieve that?

When I hear comments like "we have always done things like this, why change?", it reminds me of Kodak's comments about digital photography some years ago: "no one would ever want to look at their pictures on a video screen".

All this said I understand that probably 2/20 is the way to go when launching a new fund. Thanks for your comments.

You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

svisstack


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-09-23 19:19
>> it reminds me of Kodak's comments about digital photography some years ago: "no one would ever want to look at their pictures on a video screen".

People saying stupid shit all the time. I don't think this can be an anchor/starting point for anything.

Time well wasted.

HitmanH


Total Posts: 444
Joined: Apr 2005
 
Posted: 2015-09-23 19:37
I don't agree re: "people that decide to invest with you if you charge them 1+15 would most likely have invested if you charged 2+20 anyway"

Espeically in the CTA space - there has been a proliferation of established, multi-billion managers (in Europe - GSA, Cantab, or US - AQR) who (and their motivations are different as to why they do this) launching low fee versions of what they do.
They're been very good at going to some pension fund trustees - and getting investment.
Those trustees are approaching other managers it likes now - and saying that we'd love to diversify into a basket of 3-4 CTAs - but given fees they can't justify it

Yes - they should look at net performance -and that's all that matters - but they don't - and use BS such as what their members get paid. Happens from state (Superannuation in Aus) pension plans too.

And yes - if you hold tight, some investors do walk away (some back down too of course...)

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-23 19:42
svisstack,
what I mean is that the hedge fund industry as we know it has been around for only ~20 years, so it's a bit hazardous to say that the classic 2/20 fee structure is here to stay forever.

hitman, thanks for the note about lower fees for pension funds, that is definitely an investor I target, good to know!

You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

RFMontraz
NP Italian Stallion

Total Posts: 2014
Joined: Mar 2004
 
Posted: 2015-09-24 08:24
@ HitmanH

I believe that at the heart of our disagreement there is a fundamental misunderstanding about the purpose of this thread.

If the purpose was "if I were a multi-billion fund manager what sort of fee structure should I apply and what are the pros and cons" then ok, we can talk about what Winton or Cantab do to attract more assets, how Citadel pays the bonuses to its traders and of course (because no such discussion will ever be complete without it) of Rentec Medallion and its humongous fees. We can go on for hours dropping off names and trivia of famous billionaire which most likely we do not know personally (I for one certainly don't) but to me this looks like the people that, ice-cream in hand, take a stroll down at the Monaco harbour to stare at 60+ meters yachts before jumping back on their Panda and go home.

In my understanding in this thread TSWP was asking about what fee structure should he apply to his own HF start up, if it ever gets off the ground. I wish him all the success in the world as he comes across as a very nice person but let's face it, this is not going to be Eton Park (name dropping is alive and well) or we would not be discussing it here. Either I am the biggest loser/pessimist ever or the only pragmatist left but it's time for me to say it: no pension fund will invest (consider yourself lucky if you get a meeting and a free Evian), so their preferences are hardly relevant. If you launch with more than 50M you will be my hero. Goldorak said that most HFs have 200M like it's a pittance and that's insane, there is a 0 too many in that number. Most HFs (and CTAs) have a few millions and most close doors within a couple of years. Many (certainly more that the multi-billion fund structures constantly mentioned here) do not even get to open their doors. It seems there is a disconnect between reality and fantasy, where all of a sudden the gods (and their luck) are the benchmark to beat and gazillions are just waiting around the corner - and where pension funds invest in start ups because they pitch lower fees.

Sorry gotta jump now, I have Swensen on hold on line 2...
Wink

HitmanH


Total Posts: 444
Joined: Apr 2005
 
Posted: 2015-09-24 08:36
Maybe I broadended it up to a more general discussion of fee structuring in the industry right now
As experianced by a sub $1bn firm, but hey, I also think that I'm you're your hero :-)

Scotty


Total Posts: 721
Joined: Jun 2004
 
Posted: 2015-09-24 10:27
Awesome input RFM even I don't agree with all of it.

On an iPhone from a beach in the Maldives so I won't elaborate too much, however here are a couple of thoughts...

Perhaps an inflexible approach to HF fee structures makes it difficult for small hedge funds to survive long in a world that has much higher expectations for necessary infrastructure, people, processes than before. How about a mgt fee that scales with actual costs in a transparent way? A higher % at smaller AUM would help the small funds survive and a fee decreasing in AUM may mitigate the asset gathering that goes on in the larger funds.

With respect to investors my view is that they are clients not trading counterparties. We should be trying to work with them to find dimensions of a risk reward profile that works for them rather than seeing what we can get away with in an apparent win-lose situation. I acknowledge AndyM's point that institutional rigidities make this hard for certain investor types, but that doesn't mean you shouldn't try.

Finally, on the performance fee I'm sure there are alternatives to 20% of the upside that make both the investor and the hedge fund manager better off.

Anyway back to the bar...

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

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-24 11:15
The discussion on this thread has been great and very helpful, RFMontraz you have brought a reality check and that is good - I like the analogy of walking with an ice cream watching boats in MonteCarlo and then driving away in a Panda, in a way it feels a bit like that...

So, trying to sum up everything, coming up with a proposal, what would you gentlemen say of this fee structure:

1.5%-to-2% fixed yearly management fee
20% incentive fee but charged only on the portion of the profits that actually beat the benchmark (example if I make 10% returns and the benchmark makes 11% return, I charge NO incentive fees).

crystallization frequency: yearly

lock-up period: yearly

Rationale:

*Fixed fee is the bread and butter of the manager, hard to do without, and in the end investors have to pay those type of fixed fees also to go with mutual funds, so I think it's OK to keep it like that.

*Incentive fee is where I am going to be called a moron by other managers, however, I think the investors should be happy to pay 20% only when I beat the market, and pay no incentive fees when I do not beat the market. It would be good to speak to some investors and see what do they think of this: will they still leave me at the first year of under-performance if they know they won't be charged a 20% incentive fee?

*Lock up periods and crystallization unfortunately can't find a valid rationale because they inevitably favor the manager OR the investor, so let's find a meeting point: you stay with me at least 1 year and I will charge you at the end of each year (fixed fees actually charged monthly, but incentive fees yearly, at year end).

Comments welcome... thank you gentlemen.


You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

HitmanH


Total Posts: 444
Joined: Apr 2005
 
Posted: 2015-09-24 11:30
On the lock - investors will HATE a hard lock - if you trade liquid assets
Although they are sensible that you have to run a business, and care about stability etc - hence make it a soft lock (fees) - and charge somewhere between a quarter and a year's management fee (dependant on how long they've been in) - From my experiance - they understand that...

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-24 11:46
OK, thank you, understood.

I plan to trade only liquid assets (Futures and FX Spot), low-to-midfrequency, so if I change the lock-up system then I probably want to re-think the crystallization frequency because that was a trade-in: in change of the 1 year lock up period I offer the investor-favorable 1-year crystallization, but if the investors prefers to leave at any time (at the cost of a small exit fee), then I need to lock in the incentive fees more frequently (assuming the investor will leave when we are under-performing so I cannot charge any incentive fee at that point).

You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

RFMontraz
NP Italian Stallion

Total Posts: 2014
Joined: Mar 2004
 
Posted: 2015-09-24 19:41
Sorry to keep repeating myself, but the "if ain't broken don't fix it" applies here. Make it more complicated and you will have any sort of unintended consequences. For example regarding Scotty's suggestion, my obvious thought as investor is "sounds great call me back when your AUM exceeds X then", which would get you in a horrible Catch-22 situation.

Lock-ups are "the horror the horror" and a conversation stopper. Who cares if you charge 50 bps a year less when I cannot get my money back? Or course you can hide in the offering document gates provisions (they are pretty much standard) hoping people won't notice/ask, but that is a completely different story.

Also - just for clarity, do not want to be pedantic - lock ups and crystallization frequency do not go together: with yearly crystallization frequency if an investor redeems after one month, he will still owe you performance fees (if any are due), which will be accounted for with equalization credits or series shares depending on the structure etc... so I don't see an obvious trade off there.

Finally TSWP, noble ideals on the side, you are talking about running a business and trading is the easy part: so unless it's a de minimis set up which costs you (actually costs the investors) 50K a year, a one man band that trades from the living room and only needs a BBG (and there is NOTHING wrong with that) ok waive the man fees, do whatever you think it's more commercial, downside is limited, you can experiment; but if you are talking about a real office with people inside (as it seems the case given the pension fund comment) you need to calculate your cash flow and working capital well, like in any other business. It will cost you hundreds of Ks every year to run the gig, and this for a modest set up which will not make so you proud when receiving investors. That's why I would think twice before being so cavalier about fees, that's all.

Edit [for a further reality check]: I went to dig up a presentation I received last week, from a friend of mine. Proper HF structure, based in London. Bunch of traders, staff, road show in US etc.. very credible. Starting capital 30M USD (with the M, all their own) operational capital 8M locked up for 4 year. VERY impressive numbers, especially the second one (it means 8 USD of own money to be dedicated to make sure the firm keeps being around in absence of fees). So, lots of "interests" received during road show. Actual outside capital raised? I think zero. Did I give money myself (not that I count for shit anyway)? No. Why? No track record (at the actual fund, no cares about unaudited banter from IB days), no party. As Bon Scott sang, "it's a long way to the top if you wanna rock and roll..."


svisstack


Total Posts: 303
Joined: Feb 2014
 
Posted: 2015-09-25 00:06
>> No. Why? No track record.

I will quote @Tradenator post from other thread (http://www.nuclearphynance.com/Show%20Post.aspx?PostIDKey=177812).
@Tradenator "PhDs are a good marketing asset."
So probably they have not enough PhDs on board.
ehuaeuha

---------

Great post anyway, probably one of very few people here with usable practical knowledge about shit.


Time well wasted.

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-25 00:38
RFMontraz,
thanks for bringing some color into the thread and for all the suggestions. Worship
I loved the story about the 30M fund, please keep pouncing in with similar examples, they help to frame the issue...

You know, all this discussion for me started as a brainstorming, I am an analyst/researcher, so I tend to analyze and dissect things to see if they're good or not, I don't accept veritas upfront without closer examination, so I am here pingponging ideas with you guys to hear your expert reprieval, suggestions, honest criticism, etc., it's been a very interesting conversation so far.

Anyway, don't worry: before I decide to use a fee structure different from the usual 2/20 I will think and re-think over the whole thing a hundred times - if I am not convinced of the benefits of "innovation", I will simply stick to "tradition".

You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-25 15:21
After looking at the investment food chain below, I think I understand better why my quest for a better fee structure may appear naive and pointless to some.

When I used the word "investors" in this thread, I mostly referred to entities that can be U/HNWI or institutions that have a direct interest in allocating money with me and getting a good return but also low, meritocratic fees, because there is a direct relationship between us, where they have money, I have know-how to use it to produce returns for them, and we are in business together. That fee structure relationship is what I was trying to improve.

However, if we look at the image below, and we see the hedge fund industry as the top predator at the peak of a pyramid that has 2 more predators underneath (FOFs and Pension Funds) each one of these 3 predators is feeding on top of each other until the last one preys on the cattle at the base (the returns made by individual investors pension money), and we go from an initial 10% Yearly Gross Return for the investor to 2.86% Net Return after everybody has taken its chunk of the pie, well then I clearly can see why "investors" (FOFs or Pension Funds) won't really care about changing the 2/20 status quo, as long as the cascade of costs is dumped onto the next level (lower predator), all the way down to the pension investors.

Changing a 2/20 fee inside this chain doesn't make any difference to the world (in fact the other predators in the chain may raise their fees at that point, to eat away the extra fat left over from the HFs!).


(the "Return on investment" table is taken from Lars Krojier's "Money Mavericks").

The problem I see anyway with this food chain is that sooner or later someone will find the way to offer the cattle the same service for a much lower fee and at that point the industry will have to lower its fees, or decline in size, or charge fees only when it can demonstrate actual outperformance (alpha) and not just a ton of lucky beta.

This kind of industry disruption is inevitable, it happened everywhere in our modern world, Uber recently, and previously the economic airlines, the downloadable mp3 music (now spotify streaming for a fee), AirBnB, etc., these are all examples of what can happen when an industry does not do its best to serve its clients some real value (i.e. alpha, not beta) at the best possible price.

If someone really believes that this is not going to happen also in the investment industry, good luck.

So, in the end, the issue I have raised with this thread (how to improve fee structures) stands, regardless the fact it may be impossible to find a solution right now (especially a solution that satisfies the managers that are so used to the very nice 2/20).

You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

goldorak


Total Posts: 1000
Joined: Nov 2004
 
Posted: 2015-09-25 18:07
Just for the record, a pension fund would never pay 1/10 to a FoHF or they are blatantly stupid. Make it 30bps and 10% above an horrendous benchmark, typically 10% above Libor+500.

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

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-09-28 10:35
At the end of the day, and following the predominant suggestions, I would probably go with a 2/20 (or something around there), if I had to start up something this morning.

However, if I was in a position to change fees structures, years from now, in the light of the latest comments from Hitman and RFMontraz (both comments very appreciated and helpful), I'd change what I proposed previously as follows:

- Management Fee: somewhere between 1% and x%, I can't say it now because without knowing exactly the performance on the fund with x AUM, after a few years and without knowing exactly a lot of other things, is hard to say what % the investor should pay to stay with us. I agree with Goldorak's and Hitman's suggestions that the fee is something to be paid to access a (good) manager's services, and that automatically includes the manager's costs, so if a manager is good it should have the right to be more expensive than a Vanguard index fund at 0.2% a year.

- Incentive Fee: 50% of any return made ABOVE the benchmark, calculated specifically on each single market traded, benchmarked against itself (e.g. EURUSD's FX Spot benchmark is EURUSD FX Spot). No incentive fees for returns below the benchmark (see next point for more on this). We do not use Sharpe or other risk metrics to validate the fees, only the % return above the benchmark during the period where the trade was open (even if it is just a few seconds).

- Crystallization Frequency: fees are calculated at the end of each TRADE , on the basis of the relationship with the benchmark, if the returns of the trade are greater than the returns on the benchmark in the time during which the trade was executed, the manager takes 50% of the returns on that trade.

- No lock-up periods

- Exit fees/gates: yes, possibly with some improvements (don't worry, I'll spare you that).


You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.

TSWP


Total Posts: 383
Joined: May 2012
 
Posted: 2015-10-03 10:43
I wonder if people has forgotten that the 2/20 fee structure originated from Alfred Winslow Jones in the late 40s - I always wondered why nobody ever questioned it...

Jones decided to take 20 percent of profits as compensation, invoking the Phoenician sea captains who kept a fifth of the profits from successful voyages (sic).

So, the rationale for the 2/20 fees in today's HF industry goes back to the Phoenicians, one may argue that these were very wise people, but I am just wondering how dumb modern hedge fund investors must be to accept these high fees without any rationale behind it? oh yeah wait a second... the rationale is that if they were lucky and their ship didn't sink then the owners of the cargo had to give them a chunk of it!

Gimme a break.

Btw Alfred Winslow Jones charged no fee unless he made a profit. He had some decency.


You have your way. I have my way. As for the right way, the correct way, and the only way, it does not exist.
Previous Thread :: Next Thread 
Page 3 of 6Goto to page: 1, 2, 3, 4 ... 5, 6 Prev Next