Paper recommends money managers “eat your own cooking”
| Jul 18th, 2010 | Filed under: Academic Research, Investment Management Fees, Today's Post | By: Alpha Male |
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Since the birth of the hedge fund performance fee over 60 years ago (see our “Performance fees as old as portfolio management itself”), this form of compensation has drawn fire from some investors and professional jealousy from asset managers who did not use it. At the heart of the problem is the “free option” that upside participation with no downside represents. Making matters worse, this option – like all others – is worth more when volatility is high. And since the managers themselves influence the volatility of their funds, this represents a serious moral hazard. Needless to say, creating an effective performance fee contract can be a complicated and mathematically ugly process.
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On a large scale, it’s amazing how much morality is or should be involved in investing. Numbers and stats aside, when it comes down to it, incentives can often alter the way people react in a situation. And, I think that the most effective way to keep people honest is to up their own, personal ante or, as you put it, get some “skin in the game.”