By: Lex, FT.com
Published: October 31, 2006
Alpha Male is a big fan of FT and FT’s new “Alphaville” website in particular. But I’d like to take issue with another pseudonymous scribe regarding a piece appearing on FT.com October 31.
In an attempt to scare investors on Halloween Night, the FT’s “Lex” makes some fallacious arguments about hedge fund fees that are downright spooky. If you don’t subscribe to FT, you can get a free trial to view this article. But you’ve undoubtedly seen this type of anti-hedge fund diatribe before anyway.
As the chart to the right illustrates, says Lex, hedge fund fees have not come down even though hedge fund returns have been diminishing.
We respectively submit the following:
1. As the chart clearly indicates, performance fee rates have remained constant at around 20%. With falling returns, overall hedge fund fees have therefore actually fallen. That’s a lot more than can be said about mutual fund fees – which, because they are based solely on assets under management, have remained stable even though their returns have also fallen.
2. The chart also shows that hedge fund management fee rates have not increased. They remain stable at around 2%. As we have argued many times recently, 2% for un-correlated or low-correlated returns is a steal compared to the fees paid for the scant amount of uncorrelated (alpha) returns embedded within many mutual funds. For example, if the bulk of a mutual fund’s return can be replicated with an ETF at an annual fee of about 0.20%, imagine what the implicit fee must have been on the uncorrelated remainder.
3. Lex quite rightly shows how fees can eat into gross returns. But the returns in the chart are post-fees. Hedge fund returns, like mutual fund returns are commonly reported net of fees, making this sort of adjustment irrelevant.
4. The column suggest a “high water mark” is bad since a manager may throw in the towel if the fund goes too far below that mark. This may be true, but how is this any different than a mutual fund that lacks a performance fee both below and above its “high water mark”? One cannot simultaneously argue that a performance fee is inherently bad and that the lack of an achievable performance fee is also bad.
5. Finally, the argument that side letters giving large investors favourable fees somehow hurt “ordinary investors” is a red herring. Graduated fees are common in the long-only investment industry as they are in all industries. This simply reflects the scalable economics of the industry – not a conspiracy against “ordinary investors”.
All Hallowed Eve is a scary time indeed. But let’s stick with needlessly frightening little kids asking for candy, not investors.
– Alpha Male