Author Topic: Pabrai/Buffett partnership fee structure  (Read 60111 times)

oddballstocks

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Re: Pabrai/Buffett partnership fee structure
« Reply #10 on: November 17, 2013, 11:49:30 AM »
The structure is fair, but has a hole in my view.  If you can't earn an incentive fee in the first year or two, or you start in a bad market there is no reason to stick around and try to earn out of that hole.

Maybe this works if you're independently wealthy, but if I'm running a fund, and I need a fee to pay for food/mortgage/kids I can't be waiting around forever hoping to eventually earn a fee.  I guess maybe this could become an advantage, if I do end up waiting for years I might not have to pay child support or alimony after my wife divorces me because I"ll have no income.

A sizable drop and a quick rebound, like what we just experienced isn't much of a problem, the fee might be lost for a year.  What kills this structure is multiple years of declines, or a flat market.

Not everyone can be Buffett, I applaud anyone who's done well with this structure, although there's an element of survivorship bias in it.  Where are the stories of managers who tried it, didn't make any money and shutdown their fund and started a new one?

I like a structure where the manager is paid something, enough that they're not worried about getting another job or taking crazy risks, yet they are incentivized if they do well.
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Kraven

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Re: Pabrai/Buffett partnership fee structure
« Reply #11 on: November 17, 2013, 12:03:39 PM »
The structure is fair, but has a hole in my view.  If you can't earn an incentive fee in the first year or two, or you start in a bad market there is no reason to stick around and try to earn out of that hole.

Maybe this works if you're independently wealthy, but if I'm running a fund, and I need a fee to pay for food/mortgage/kids I can't be waiting around forever hoping to eventually earn a fee.  I guess maybe this could become an advantage, if I do end up waiting for years I might not have to pay child support or alimony after my wife divorces me because I"ll have no income.

A sizable drop and a quick rebound, like what we just experienced isn't much of a problem, the fee might be lost for a year.  What kills this structure is multiple years of declines, or a flat market.

Not everyone can be Buffett, I applaud anyone who's done well with this structure, although there's an element of survivorship bias in it.  Where are the stories of managers who tried it, didn't make any money and shutdown their fund and started a new one?

I like a structure where the manager is paid something, enough that they're not worried about getting another job or taking crazy risks, yet they are incentivized if they do well.

These are good points. I've never understood high water marks except as a matter of marketing and asset gathering. From the standpoint of managing money though why should someone have to make an investor whole before they get paid?  They did the work and oftentimes a loss is due at least in part to just overall market performance. My feeling is that unless lookups are unreasonable if someone isn't happy with performance take your money out and fire the guy.
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Parsad

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Re: Pabrai/Buffett partnership fee structure
« Reply #12 on: November 17, 2013, 11:26:09 PM »
The structure is fair, but has a hole in my view.  If you can't earn an incentive fee in the first year or two, or you start in a bad market there is no reason to stick around and try to earn out of that hole.

Maybe this works if you're independently wealthy, but if I'm running a fund, and I need a fee to pay for food/mortgage/kids I can't be waiting around forever hoping to eventually earn a fee.  I guess maybe this could become an advantage, if I do end up waiting for years I might not have to pay child support or alimony after my wife divorces me because I"ll have no income.

A sizable drop and a quick rebound, like what we just experienced isn't much of a problem, the fee might be lost for a year.  What kills this structure is multiple years of declines, or a flat market.

Not everyone can be Buffett, I applaud anyone who's done well with this structure, although there's an element of survivorship bias in it.  Where are the stories of managers who tried it, didn't make any money and shutdown their fund and started a new one?

I like a structure where the manager is paid something, enough that they're not worried about getting another job or taking crazy risks, yet they are incentivized if they do well.

In our Canadian Fund, we did not receive an incentive fee for the first five years.  Not many managers could survive that long without some form of payment.  But I think that type of survivorship is good for the industry.  There are way too many, in fact the vast majority of investment managers, making a paycheck while adding zero value for their investors that could not be achieved through passive ETF's. 

These are good points. I've never understood high water marks except as a matter of marketing and asset gathering. From the standpoint of managing money though why should someone have to make an investor whole before they get paid?  They did the work and oftentimes a loss is due at least in part to just overall market performance. My feeling is that unless lookups are unreasonable if someone isn't happy with performance take your money out and fire the guy.

If an investment manager does a good job, at some point in time they would receive incentive fees, and generally the better the job, the greater the compensation.  So the high watermark is irrelevant in terms of the manager getting paid.  The truth is, that most managers want to manage money, but not take the risk and costs associated with an incentive fee structure without any fixed management expense ratio.  It's nice if you have $50M under management and get "1 & 15", because you are guaranteed $500K a year...whether you do well or not.  Even if you manage $10M, that's a decent $100K a year...which manager is going to sweat making $100K a year for doing nothing?

And that is where the high watermark becomes incredibly important for incentivizing the manager.  You lose money, and it may be years before you get paid again.  Thus, you better be making good decisions short-term and long-term regardless of where the market goes!  Cheers!
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skanjete

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Re: Pabrai/Buffett partnership fee structure
« Reply #13 on: November 18, 2013, 12:09:38 AM »
And that is where the high watermark becomes incredibly important for incentivizing the manager.  You lose money, and it may be years before you get paid again.  Thus, you better be making good decisions short-term and long-term regardless of where the market goes!  Cheers!

That's essential. As a partner or client you want you manager to be focused on the most important thing, which  (in my view) is risk.

In the example of Buffett/Pabrai, if they lose the first year 20%, they have to make make more than 40% (i.e. 1.06 x 1.06 / 0.8) the second year just to start earning something. If it takes them 2 years to make up, they have to make 22% annualised for 2 years before earning something (i.e. sqrt(1.06 x 1.06 x 1.06 / 0.8)) .
So losing big percentages is a disaster. and the only way to do well for the manager is to deliver consistent and substantial overperformance.

The manager has a fantastic advantage since he is asymetrically leveraged, just like Berkshire Hathaway with it's float. So I think it's only fair to have some downside as well in that an underperforming manager could have to wait a very long time to earn something. If you don't add the downside, the thing gets to positively skewed for the manager, and he'll be tempted to focus too much on the rewards, and not enough on the risks of the investment process.

skanjete

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Re: Pabrai/Buffett partnership fee structure
« Reply #14 on: November 18, 2013, 12:23:24 AM »
The structure is fair, but has a hole in my view.  If you can't earn an incentive fee in the first year or two, or you start in a bad market there is no reason to stick around and try to earn out of that hole.

Maybe this works if you're independently wealthy, but if I'm running a fund, and I need a fee to pay for food/mortgage/kids I can't be waiting around forever hoping to eventually earn a fee.  I guess maybe this could become an advantage, if I do end up waiting for years I might not have to pay child support or alimony after my wife divorces me because I"ll have no income.

A sizable drop and a quick rebound, like what we just experienced isn't much of a problem, the fee might be lost for a year.  What kills this structure is multiple years of declines, or a flat market.

Not everyone can be Buffett, I applaud anyone who's done well with this structure, although there's an element of survivorship bias in it.  Where are the stories of managers who tried it, didn't make any money and shutdown their fund and started a new one?

I like a structure where the manager is paid something, enough that they're not worried about getting another job or taking crazy risks, yet they are incentivized if they do well.


I like the idea of a manager who is already financially independent.
Because if he has a track record that is worthwile, he'll be already a long way towards financial independance.
Secondly, as a partner, you don't want your manager to be pressured to take unnecessary risks because he needs the fee money to survive.
For an investor, patience is no luxury, it is a neccessity, and if your manager is being pressured by debt or by income problems, the first thing to go is the patience, and with it the rationality and prudence.

Kraven

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Re: Pabrai/Buffett partnership fee structure
« Reply #15 on: November 18, 2013, 06:14:19 AM »
These are good points. I've never understood high water marks except as a matter of marketing and asset gathering. From the standpoint of managing money though why should someone have to make an investor whole before they get paid?  They did the work and oftentimes a loss is due at least in part to just overall market performance. My feeling is that unless lookups are unreasonable if someone isn't happy with performance take your money out and fire the guy.

If an investment manager does a good job, at some point in time they would receive incentive fees, and generally the better the job, the greater the compensation.  So the high watermark is irrelevant in terms of the manager getting paid.  The truth is, that most managers want to manage money, but not take the risk and costs associated with an incentive fee structure without any fixed management expense ratio.  It's nice if you have $50M under management and get "1 & 15", because you are guaranteed $500K a year...whether you do well or not.  Even if you manage $10M, that's a decent $100K a year...which manager is going to sweat making $100K a year for doing nothing?

And that is where the high watermark becomes incredibly important for incentivizing the manager.  You lose money, and it may be years before you get paid again.  Thus, you better be making good decisions short-term and long-term regardless of where the market goes!  Cheers!

I was making a different point.  I don't disagree with the incentives, but if I am a manager and I lose money in 2008 it's not necessarily because I didn't make good decisions.  In fact, I was probably sweating it out and ruining my life for my clients.  And what do I get in return?  I have to work for free (other than my base fee) for years.  Why is that the proper way to incentivize someone?  Why not just say "if you're unhappy with me, take your money out".  If you go to a doctor and he treats you, but you still die, the bill is still outstanding.  He doesn't waive the fee.  To me, the incentives aren't necessarily aligned with highwater marks.  If I lose too much money, I'll just walk away and open a new fund.  Now maybe I'll have trouble raising money, but maybe not.  Either way, why should I kill myself when it might take years for incentives to kick back in and frankly, even if I do well clients have short term memories and the second things get better they probably still pull their money and give it to someone else. 
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Ham Hockers

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Re: Pabrai/Buffett partnership fee structure
« Reply #16 on: November 18, 2013, 06:24:47 AM »
but if I am a manager and I lose money in 2008 it's not necessarily because I didn't make good decisions.  In fact, I was probably sweating it out and ruining my life for my clients.  And what do I get in return?  I have to work for free (other than my base fee) for years.  Why is that the proper way to incentivize someone? 

So do you turn down your fees when you benefit from a hot market?

Kraven

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Re: Pabrai/Buffett partnership fee structure
« Reply #17 on: November 18, 2013, 07:12:56 AM »
but if I am a manager and I lose money in 2008 it's not necessarily because I didn't make good decisions.  In fact, I was probably sweating it out and ruining my life for my clients.  And what do I get in return?  I have to work for free (other than my base fee) for years.  Why is that the proper way to incentivize someone? 

So do you turn down your fees when you benefit from a hot market?

No.  You missed the point.
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Ham Hockers

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Re: Pabrai/Buffett partnership fee structure
« Reply #18 on: November 18, 2013, 08:05:00 AM »
No.  You missed the point.

I got your point.

Your point, that a HWM may misalign interests, partly hinges on your belief that a manager should not be punished for having poor performance which is undeserved (2008). So I asked if you would return your fees in a hot market. i.e. why should you be paid on gains that are not deserved?

Kraven

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Re: Pabrai/Buffett partnership fee structure
« Reply #19 on: November 18, 2013, 08:11:35 AM »
No.  You missed the point.

I got your point.

Your point, that a HWM may misalign interests, partly hinges on your belief that a manager should not be punished for having poor performance which is undeserved (2008). So I asked if you would return your fees in a hot market. i.e. why should you be paid on gains that are not deserved?

When you get the point, I will respond.
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