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Boston HF does away with 2 and 20
We all know how hedge fund fees work. We give them an x amount of money, and then they charge us around 2% off that as a management fee. They then try to make a y amount of money using our x, and then charge us a 20% performance fee from the y that they made. What if they lose money? Well, there’s usually a clawback clause for that – but they still get to keep the 2%.
It’s been that way for decades, millennia even, given that Alfred Winslow Jones copped the formula off Phoenician sailors. Two ex-Harvard endowment people however, seem to be trying to change that:
“A pair of former Harvard University endowment executives have built the world’s largest stock-focused hedge fund with the opposite approach. Robert Atchinson and Phillip Gross let investors in their $28 billion Adage Capital Management LP keep almost all of their trading gains—and promise refunds if the fund’s performance falters.”
According to the Wall Street Journal, Adage Capital charges just 0.5% annually plus 20% off gains in excess of the S&P 500’s return. While that doesn’t look particularly anomalous at first glance, here’s the kicker: they keep half of their performance fee locked away for the rest of the year, and it gets awarded to them only if they beat the S&P in the following year. What happens if they fall short? Well, it goes back to investors as a refund.
The break from “tradition” seems to have brought Adage its fair share of fans; the firm saw its assets under management balloon from nearly $4 billion in 2001 to $28 billion in 2015, and ex-Harvard endowment head Jack Meyer had nothing but good things to say about their fee structure:
“That’s how I think the world should look…I’m surprised it has taken the world so long to get there.”
It has cost them a King’s ransom in fees though. Last year, when the fund was up 18.4%, Adage divvied up just $400 million in fees among its 26-strong staff, a massive sum by any measure, but still much less than an over $1 billion take they would have claimed had they done the usual 2 and 20 structure. No one seems to be complaining however, as the firm’s crew seems to be more interested in winning that getting on the Forbes list.
Also impressive is the fact that they’ve only paid refunds on two occasions: in 2002 and in 2008, when the fund trailed the S&P by 0.18% and 0.75% respectively.
It also raises the question though; if their fee structure catches on – which I think it will – what does that mean for absolute return? I thought that was the whole point of hedge funds in the first place – to not be tied down by some benchmark and to just focus on making money, bull or bear market.
Its different strokes I guess, but still, I'm curious what you have to say.