Money managers under the microscope
Oaktree’s Marks takes aim at industry fee-for-all
The infamous “2 and 20″ scheme once reserved for a few stars is now the standard. Master and mediocre managers alike charge the same top-tier prices. Yet 2 percent fees for assets under management plus 20 percent of a fund’s profits should be exceptional pay for the best managers, he said, not the rule.
“Pricing in the investment management business was very uniform, and it shouldn’t be,” said Howard Marks, chairman of Oaktree Capital Management, a Los Angeles firm that manages $60 billion alternative investments. “If markets are working right, different things have different prices.”
Marks, who recently told Reuters the biggest distressed bargains were already behind us, observed investors during the good times didn’t asset themselves when negotiating terms with fund managers since they didn’t want to risk missing out on the gains.
In a recent “Chairman’s Memo” to investors, Marks observed incentive fees “should go only to managers with the skill needed to add enough to returns to more than offset the fees.” To illustrate, he noted a credit hedge fund charging 2 and 20 fees would have to earn a 16-3/8 percent gross return to achieve the same net results as a fund generating 12 percent return but charging a 0.5 percent fee.
The hedge fund manager has to outperform his rival by 36 percent more, ideally without taking more risk or piling on leverage. “How many managers in a given asset class can generate this incremental 36 percent other than through an increase in risk? A few? Perhaps. The majority? Never,” he wrote. “Thus, incentive fee arrangements should be exceptional, but they’re not.” If fund managers sold cars, Cadillacs and clunkers would all boast the same price tag.
Yet the financial crisis of the past two years has prompted investors to reexamine the fees they pay and the results they get. Some big investors, including public pensions in California and Utah announced they would renegotiate their terms. Still, contesting fees us tricky. Many of top performing hedge funds won’t budge, so investors wind up with an adverse selection of discounted but under-performing funds.
“The differences between investment managers are so large it’s unlikely that a fee discount will make an inferior investment manager the right choice,” he sad. “You probably wouldn’t choose between surgeons based on price.”