Recently, some one wanted to check with me the ‘terms’  of a portfolio management scheme being offered by a broker.

As per the offer, the portfolio manager would be paid management fees whenever he beats the ‘hurdle’ rate. And this was an ‘annual’ measurement rather than a full period one.  What it means is that let us say that in year one, the portfolio dives 20%, the manager gets no money. In year two, if the hurdle is ten percent and the fund value moves from 80 to 91, he will get management fee!! The portfolio is still under water.

SEBI should look in to this.  Fees which are based on performance, should be calculated at the end of the term or exit. Hurdle rates, should be compounded. For instance, if the hurdle rate is ten, then it should be taken to understand that the goal post is a ten percent CAGR.

 

Addendum” A gentleman pointed out that as per law, there is something called ‘high watermark’ which actually covers this. I am not very sure, but if that is so, I stand corrected.  I however strongly believe that the fee should be taken when the investor exits rather than annual basis.

 

 

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One thought on “Portfolio Management Services- Fees etc

  1. High watermark, mostly applies to the performance component of the fee and not the management portion. You are absolutely right, that hurdle rates should be compounded to qualify for management fees. Mr. Buffett and Mr. Pabrai practiced and preach charging only the performance fee and not the management fee. But we live in a society where signaling effects affect the psyche of the investors. The fund managers are obviously convinced that they deserve their 2% + 20% fee structure, the irony is that the investors convince themselves that the manager must be worth it if he charges a higher fee. Consumers make the same mistake all the time when they associate higher quality with higher tag price. Hedge fund industry by its nature is meant to be unregulated, as it is meant to be an avenue for HNIs to take the risk as per their appetite, and as SEC or SEBI are happy with controlling MFs and protecting retail investors. Before checking the practices of PMS funds which cater to a smaller portion of the population, the regulator should check the MFs and their agents for miss-selling practices. Just today I visited a Karvy branch where stood a 5×5 kiosk meant for road display, where Karvy was marketing MFs with hopes of up to 30% returns. Where do you think the investor would lose more? Also, consider the wherewithal of both groups of investors.

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