Overpaying For Performance?
I suppose one of the bugbears of many investors, large and small in every market is the amount of money fund managers make and the excuses they invent when they don’t perform.
The complaints are similar the world over, even from someone like Warren Buffett.
…………………………….
Wall Street’s Pied Pipers of Performance will have encouraged the futile hopes of the family. The hapless Gotrocks will be assured that they all can achieve above-average investment performance – but only by paying ever-higher fees. Call this promise the adult version of Lake Woebegon.
In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd (that’s private equity).
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.
Let me end this section by telling you about one of the good guys of Wall Street, my long-time friend Walter Schloss, who last year turned 90. From 1956 to 2002, Walter managed a remarkably successful investment partnership, from which he took not a dime unless his investors made money.
My admiration for Walter, it should be noted, is not based on hindsight. A full fifty years ago, Walter was my sole recommendation to a St. Louis family who wanted an honest and able investment manager.
Walter did not go to business school, or for that matter, college. His office contained one file cabinet in 1956; the number mushroomed to four by 2002. Walter worked without a secretary, clerk or bookkeeper, his only associate being his son, Edwin, a graduate of the North Carolina School of the Arts.
Walter and Edwin never came within a mile of inside information.
Indeed, they used “outside” information only sparingly, generally selecting securities by certain simple statistical methods Walter learned while working for Ben Graham.