25 August 2020

This is Worse than I Had Imagined

I knew that hedge fund fees were excessive, but run the numbers, and it is beyond my wildest imaginings.

Their fees amount to 64% of all returns:
If you already see hedge fund fees as exorbitant, you ain’t seen nothing yet. Over the past two decades, the hedge fund industry has kept 64 cents of every dollar of gross profits that it has generated above the risk-free rate.

You’d be excused for thinking this is a mathematical impossibility. The predominant fee arrangement in the hedge fund industry is the so-called 2-and-20 fee structure, under which a fund charges an annual management fee of 2% of assets under management and a performance incentive fee of 20% of any profits. So how can hedge funds keep more than 20 cents of every dollar of profit, on top of management fees?

The answer is provided in a new study that the National Bureau of Economic Research recently began circulating. Entitled “The Performance of Hedge Fund Performance Fees,” the study was conducted by finance professors Itzhak Ben-David and Justin Birru, both of Ohio State University, and Andrea Rossi of the University of Arizona.

The professors analyzed a comprehensive hedge fund database containing nearly 6,000 funds over the 22 years from 1995 through 2016. Over that period these hedge funds collectively produced total gross profits of $316.8 billion. Of this total, fund managers kept $202 billion ($88.7 billion in management fees and $113.3 billion in performance incentive fees). The remainder—$113.3 billion, or 35.8% of total gross profits — went to investors. (See the chart below.)
That is almost 2/3 of returns, which means that even by hedge funds extravagant claims, they would never exceed the numbers of things like index funds.


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