Subject: Re: OT: Money Manager Performance Based Fee
rayvt: If the S&P500 does 10% and he does 13%, he gets 25% of the 13%, leaving you with net 7.5%.
How many of these people consistently beat the S&P500 by more than 3%?
If he gets 25% of 13%, you are left with 9.75%, not 7.5%. But yes, it does get rather tedious to figure out the details.
I made the following table to try to compare a 1% AUM advisor matching the SP500 to a Fee Advisor delivering 3% more than the SP500.
The SP500 returns are invented for the next 10 years, and at 5% are on the low side since that's what folks expect.
The Fee advisor delivers 8% annual return for the next 10 years, but with larger variation in returns and not that correlated to the SP500.
Portfolio is initialized at $1M and the fee advisor gets paid 25% of the gains (above previous year-end high) at the end of each year.
The fee advisor earns nothing if the portfolio value at the end of a given year is lower than any prior year-end high.
(That is, if the advisor delivers negative returns, he earns no fees).
SP500 SP500 Value 1% AUM Adv 1% AUM Fee Adv Fee Adv Fee Adv Fee Adv
Year Return Raw Value Net Value Fee $ Return Raw Value Net Value Fee $
1 14% $1,140,000 $1,128,600 $11,400 26% $1,260,000 $1,195,000 $65,000
2 -8% $1,048,800 $1,027,929 $10,383 22% $1,537,200 $1,392,175 $65,725
3 25% $1,311,000 $1,272,062 $12,849 -15% $1,306,620 $1,183,349 0
4 5% $1,376,550 $1,322,308 $13,357 -7% $1,215,157 $1,100,514 0
5 -4% $1,321,488 $1,256,722 $12,694 36% $1,652,613 $1,470,568 $26,131
6 12% $1,480,067 $1,393,453 $14,075 4% $1,718,717 $1,514,685 $14,706
7 18% $1,746,479 $1,627,832 $16,443 -27% $1,254,664 $1,105,720 0
8 -25% $1,309,859 $1,208,665 $12,209 50% $1,881,996 $1,622,607 $35,974
9 16% $1,519,436 $1,388,031 $14,021 12% $2,107,835 $1,768,641 $48,678
10 8% $1,640,991 $1,484,083 $14,991 5% $2,213,227 $1,834,965 $22,108
Final Value $1,640,991 $1,484,083 $2,213,227 $1,834,965
Total Fees $0 $132,421 $278,322
Loss Due to Fees $0 $156,908 0 $378,261
Total Return 64% 48% 121% 83%
CAGR 5.08% 4.03% 8.27% 6.26%
With this scenario, the 8.27% raw return that the fee advisor delivers is reduced to 6.26%, slightly higher than the SP500 return with no fees.
And comfortably higher than the 1% AUM advisor who is just indexing.
Assuming I don't have mistakes in there, this argues that the 25% fee may not be as onerous as it seems.
And this "0 and 25" fee schedule is probably better than "2 and 20", unless the latter has a hurdle rate.
Mark