11 Oct 2013

Last week, one of the most successful hedge funds apologised to its investors. “The Pershing Square funds declined by more than 5% during the third quarter of 2013 generating flat performance net of all fees for the first nine months of the year.” This is an unaccustomed setback for Bill Ackman, the founder of the fund, whose personal net worth, according to Wikipedia, is $1.2bn. It is not news that the most successful few hedge fund managers make money on this scale, nor that the fees charged by hedge funds are high (typically, 2% of funds under management and 20% of gains, sometimes above a benchmark level, annually). So it’s turning out to be a bum year for Bill. To mitigate his shame and sorrow, Mr Ackman includes the performance of his fund since inception on 01/01/2004. Its gross return is 780% which is very impressive but less striking than its net return, after fees. That is 433%. Mind the gap. Every time that the investor, who is putting his money at risk, has made a dollar, Mr Ackman has made 80 cents. Never mind. Investors since inception have had a wonderful performance and would probably have bitten your arm off if offered those returns and those fees at the beginning. But that’s not quite the end of the story. Were a terrible and unimaginable financial event (say, a default by the USA) to happen, resulting in a devastation of the fund’s performance, that 433% return after fees could start to shrink rapidly. But the fees themselves are safe. They have been paid, in cash. The last paragraph of my last investment rule states: Always be thinking about how and when you are going to get paid out. Mr Ackman is a highly talented investment professional, who, like all hedge fund founders, probably thinks about this question a great deal. He is all over it. I fear that one cannot say the same for his investors. The dollars they have made are accounting profits whereas the fees they have paid are in cash. I have picked on Pershing Square because it has been very successful. Most hedge funds are not. A paper last year...