Performance Fees: Paying the piper even when the band doesn’t show up
Mar 11th, 2007 | Filed under: Investment Management FeesLast week both Ford and Delta got off their deathbeds to hand out goodies to many of their employees. Response was swift as bloggers and columnists asked why a company like Ford that lost $12.7 billion last year was in a position to hand out anything at all. “What a waste!”, bloggers wrote. “It’s all so hopeless”, “Nothing ever changes!”.
Hedge funds of funds face a similar problem nearly every year. Typically, a single hedge fund charges a 2% management fee and a 20% performance fee. A fund of funds then adds a further 1% management fee and often a 10% performance fee of their own. So on the surface, the nickname ”fees of fees” may seem appropriate to some.
But the effect of dual fee layers is more complex than it looks on the surface. An article by Mark Hulbert in last weekend’s New York Times (reprinted here in Friday’s IHT) fees refers to an MIT study on the “deadweight” fees paid by hedge fund of funds investors. The paper explains that an end-investor in a fund of funds often ends up paying performance fees even if their fund loses money because some underlying managers are always bound to produce positive returns. Ironically, the source of this problem is the very reason funds of funds exist: diversification.
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