Buffett and the “2-and-20 crowd”
Apr 6th, 2007 | Filed under: Investment Management FeesWho am I to question the Great One? He’s produced 21% CAGR for 40 years and I don’t even use my real name when I write blog postings. But I have to push back a little on Buffett’s entertaining, but somewhat misleading salt-of-the-earth populism. It certainly sells tickets at the Qwest centre, but it’s an unhelpful contribution to the important debate over investment management fees.
In fairness, Buffett is one of then world’s most successful producers of alpha - beating the S&P500 by an average of 10%p.a. over the past 4 decades. But he takes his usual swipe at the “2-and-20 crowd” in his recently released 2006 investment letter. We commend his implicit emphasis on alpha as the raison d’etre for fees, but he is too quick to assume hedge funds simply deliver beta. Here’s an excerpt:
“A flood of money went from institutional investors to the 2-and-20 crowd. For those innocent of this arrangement, let me explain: It’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you a bundle – and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide. For example, a manager who achieves a gross return of 10% in a year will keep 3.6 percentage points – two points off the top plus 20% of the residual 8 points – leaving only 6.4 percentage points for his investors. On a $3 billion fund, this 6.4% net performance will deliver the manager a cool $108 million. He will receive this bonanza even though an index fund might have returned 15% to investors in the same period and charged them only a token fee.”
Buffett says the “2-and-20 crowd” is paid two percent of your principle - as if traditional (mutual fund or investment advisory) fees are paid out of something other than principle(?). This linguistic acrobatics reveals an obvious bias that calls into question his objectivity on the issue.
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