Why Don't Progressives Use Their Power as Hedge Fund Customers to Challenge Hedge Fund Compensation?

Kevin Drum observes that the top 25 hedge fund managers earned $13 billion in total, including one hapless dude who made $250 million despite losing money and shutting down the fund.

I will say that I have always scratched my head over asset manager compensation.  The tradition is that they get paid as a percentage of assets managed, sometimes with a percentage of the profits as well but never taking a percentage of the losses.   Perhaps this made some sense with smaller pools of money, but today with huge pools of money, the same old percentages yield ludicrous compensation results.  I certainly understand why the managers would defend this compensation scheme, but why do customers accept it?

This reminds me of real estate broker compensation.  The tradition when I grew up is that the seller paid 6%, about half of which went to the seller's broker and half to the buyer's broker.  For years that 6% was etched in stone and no one broke ranks -- the agents were pretty good at maintaining the cartel, and the government helped by putting the force of law behind broker licensing that helped keep the agent supply down.  But as home prices kept increasing, people started noticing that while 6% of $100,000 may have made some sense as reasonable compensation, 6% of $2 million was absurd, especially since a $2 million home was not even close to 20x harder to sell.   So people, initially savvy high net worth folks, and later everyone, began negotiating the 6%.  I have negotiated this number on every home I have sold since the mid-1990s.

I am not really knowledgeable about the asset management business -- in some sense I have negotiated my commission by choosing to put all my money in low-fee Vanguard funds.  How does the asset management business hold the line on fees, particularly when they are in a business where it is so easy to measure their relative performance, and presumably pay them based on this performance?

Which got me to thinking about the customers of hedge funds.  Aren't many of these customers progressive or controlled by progressives?  Hedge funds have been very successful marketing to university endowments, non-profit foundations, and public pension funds -- aren't these institutions often controlled by progressives, or at least left-liberals?  Aren't a disproportionate share of the very high net worth Hollywood and billionaire types who invest in hedge funds also progressive or liberal?  Heck, Hillary Clinton's son-in-law ran a hedge fund until recently.  So why don't these folks get together and instead of worrying about whether their portfolios are invested in Israel or Exxon or some other progressive bette noir, why don't they agree to a set of principles as to how they are going to pay for their asset management services in the future, and stick to these?  I say that progressives should get together, because they are politically passionate about this, but I can't think of any good reason why good libertarians or conservatives wouldn't happily join in to reduce their fees.

I understand that to the extent that there are black swan hedge funds that beat the market year in and year out, these folks will be hard to challenge as they can probably write their own terms.  But for the other 99% of hedge funds, why not use the power progressives already have as customers before we start talking about various government hammers.

PS-  I will put my two cents in.  I think the new Mother Jones site design is awful.


  1. SamWah:

    I'll take your opinion on Ma Jones; I won't look at her.

  2. Ike Pigott:

    This is silly. If you don't like the site design at Mother Jones, why don't you leave a comment over there where they will see it and take your sugges

    Never mind.

  3. morganovich:

    "but why do customers accept it?"

    it's simple. customers care about volatility adjusted net return. it's that simple.

    as a customer, you do not care what the fees are. you care what the return net of fees is.

    would you rather pay 0.25% on a 5% gain or pay 2.5% on a 10% gain?

    the actual size of the fees is irrelevant.

    then you have to add in risk preference. would you rather earn 5% with very low volatility or 8% with more risk of ups and downs? that's a subjective preference thing.

    but that guys that are good at providing stable returns and not taking hits in big down years (like 2008) are a scarce commodity and they command higher fees.

    there are, to be sure, a lot of bad funds that charge fees that are out of line and make the net number suck. some get by on connections, others marketing, and others structural issues and cronyism, but by and large, the real issue is just net returns and volatility over time.

    the other problem that arises is that capital markets are a handicapping system. if you can beat the market, then people give you money. but at a certain point, the size of your assets makes generating returns harder. it limits your pool of possible investments, increases slippage getting in and out of positions, etc. it's like adding weight to a horse. at a certain point, you can no longer win.

    this is why many big funds see returns drop. the guys with enduring high returns close their funds to prevent this and/or give assets back.

    i don't think you are looking at this quite the right way.

  4. ErikTheRed:

    You realize that for progressives, actually doing something about their problems themselves instead of whining to the government would require a 100% change in their entire outlook on life, right?

  5. johnmoore:

    This is suspiciously like the selection bias that makes mutual funds look good and some managers look like wizards, even though the field does not outperform the market indexes.

    There, losing funds are shut down, so they disappear from the stats. Winning funds continue (until they lose). And, just by statistics, some fund managers will do well a lot - not because they are good, but because they are lucky.

    I would be surprised if this isn't the real situation in hedge funds today.

  6. Eau de Javelina:

    Fees are beginning to decrease because performance is fading. Too many hedgies chasing too few opportunities. As for lower volatility investing, buy an index fund with half your money and short term bonds with the other half. Voila, half the volatility while maintaining some beta.