In our experience many (or at least most) hedge fund managers are excellent at managing their portfolios but are often much less proficient at setting the best price level for their services. Fee structuring may range from a more aggressive “what the market can bear” approach to a “marginal cost pricing” approach. In the case of the latter, once a firm reaches its break-even point on a perceived sustainable management fee income level, any and all new investment products could be sold at marginal cost levels, which in practice is very close to zero.
From a basic macro-economic perspective, the “what the market can bear” approach is the most rational approach, at least in the short-term. Managers whose investment skill set are in high demand can set their price level higher than other managers. Without naming names, there are examples of 3% management fees and/or 25% performance fees. This approach is defendable when the manager can show consistent alpha even after these fees are applied. However, few (if any) managers consistently do so year after year. The risk in a weak(er) year for the manager is that investors will more easily turn on the manager and take “revenge” for having paid such exceptional fees.
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