Happy New Year, everyone.
A few days ago I came across a terrific post by Terry Smith on his blog, Straight Talking. Using Warren Buffett's investment returns, he illustrates why the two-and-twenty standard is egregious. Hedge funds win disproportionately when they charge 2 percent on assets and keep 20 percent of the profits.
Here's what Smith writes:
As you are aware, Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46% pa. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.3m.
However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2% of the value of the funds as an annual fee plus 20% of any gains, of that $4.3m, $4.0m would belong to him as manager and only $300,000 would belong to you, the investor. And this is the result you would get if your hedge fund manager had equalled Warren Buffett’s performance. Believe me, he or she won’t.
At first I could not believe Smith's conclusion—managers keeping over ten times what their clients make. It was a "say it ain't so" moment. That's why I took a break from college football yesterday to pick through his spreadsheet model.
Bottom line: I can quibble with a few of the model assumptions, but I think Smith's conclusions are right on the money. Hedge fund fees scuk.
* Scuk means what you think it means—but worse.