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There should be a fund that guarantees a return in excess of an index (adjusted for fees). In exchange the fund managers would get fees and excess returns on t

by jwally 6y ago

There should be a fund that guarantees a return in excess of an index (adjusted for fees). In exchange the fund managers would get fees and excess returns on their clients capital. This way instead of arguing over which approach is better, both groups can benefit from one another. An example could work like this: Someone (Goldman, why not) starts a fund called the AlphaPlus fund. Its a mutual fund. You pay a 10% up front commission to get into it, and can withdraw your money whenever you want. Goldman promises to return the exact same as the S&P 500 *PLUS* 1% apr. Say I hold for 5 years and want to get out. The S&P goes up 10% per year during that time. Goldman owes me whatever an 11% rate of return on whatever I invested up front. Say I hold the fund for 5 years and want to get out. The S&P has a rate of return of -12% apr. Goldman owes me a -11% rate of return on my principal. Goldman does this because they get a fat 10% upfront fee from me, plus they can use their super-wizard skills to invest my money in something that returns like 30% apr. Thus, their profit is fees + however much they can beat the market by (and the 1% they owe me). (edited to give better example given access to keyboard)

mettamage 6y ago
Could you give an example? I am rereading your sentences but I just don't understand what you're saying. I feel silly, but I really don't get it.
nabla9 6y ago
You don't get excess returns without risk. If you want guarantees, it will cost you extra. Nobody manages your money for the kindness of their hearts. Several funds have performance fees. It's typically the high-water mark (HWM) fee for profits above reference index returns.
- chollida1 6y ago
  Just to be clear a high water mark isn't a hurdle rate in the sense the OP was talking about. In hedge fund land a high water mark means that if a fund loses money they won't take fees again until they've gotten back to their original high water mark. ie you invest at 100, they gain 10% after fees so your units are worth 110. The next year they lose 10% so your units are worth approx. 99. Now the high water mark is 110. Next year they make 5% so your units are worth approx. 104%. T his year the fund doesn't take performance fees as they haven't cleared their high water mark yet. Point being the high water mark is relative to their own fund and has nothing to do with the market or any other benchmark. If a fund only takes performance fees after a certain hurdle rate that is becoming more common but would be described by some other term.
bidirectional 6y ago
This is called a hurdle and many funds use them. Buffet's bet was against funds of funds which are basically indices tracking certain hedge funds, not hedge funds themselves.
CapriciousCptl 6y ago
Ironically Buffett started with exactly this over half a century ago-- setting a cumulative hurdle rate of 6%-- meaning he wouldn't take fees unless investors made at least 6%. He beat the Dow (S&P 500 wasn't really a thing during the Buffet Partnerships) every single year.
missedthecue 6y ago
Almost all hedge funds have a hurdle rate
pedrocr 6y ago
If Goldman had a way to guarantee returns above the market why would they sell that to anyone? Or put it another way, who is the sucker that is taking the other side of those Goldman trades to get returns guaranteed to be below market? Total market returns are zero sum.
- Gustomaximus 6y ago
  The why is access to additional capital.
- jwally 6y ago
  Say Goldman can beat the market by 20%. They sell you a fund that promises to beat it by 1%. The additional 19% return on YOUR MONEY they keep. You are guaranteed alpha at exactly 1%. Goldman makes fees and infinity ROI for taking risk. Win-Win.
  - chii 6y ago
    > Say Goldman can beat the market by 20%. if they could do that, they could just keep that 20% and they'd be already ahead. Why do they need to pay you 1% for your money?!
    - fooker 6y ago
      >Why do they need to pay you 1% for your money Das Capital!
    - edanm 6y ago
      In general (not answering this specific case), a fund wants more money under management, because they get percentages of more money that way (they have more leverage). You might be assuming Goldman has infinite money - they don't. Here's how to think of this: Say I'm an investing wizard - I can generate 20% returns on any money invested. Scenario 1: I have 100k capital, which means after one year, I'll have 120k. I made 20%, but in practice that's 20k. Scenario 2: Now say I sell to you my wizarding ability by giving you 10% and keeping 10%. I'm giving you half the upside. However, you are a rich bank that invests 100m. I turn it after one year into 120m, give you half of that and keep half, so you've gotten 10m and I've gotten 10m. Now percentage-wise, obviously I'm ahead in scenario 1, but in real terms, obviously I prefer scenario 2 - I've gotten 10m dollars instead of 20k dollars. Btw in the real world, if I have to invest more money, my prowess goes down. So with 100k I can do 20%, with 1m I can do say 19%, etc. So what you'd expect to have happen is that more and more people will invest, because it's worth it to them, until eventually my abilities go down to just generic S&P level. Up to then, it's worth it for every extra investor to invest, because even if I'm only beating the market by 1%, that's a lot, but eventually I'm managing enough money such that I'm just rivaling the S&P. So from the outside, it looks like I'm not really doing anything special, but it was totally worth it for every investor until now.

by jwally 6y ago

mettamage 6y ago

Could you give an example? I am rereading your sentences but I just don't understand what you're saying. I feel silly, but I really don't get it.

nabla9 6y ago

You don't get excess returns without risk. If you want guarantees, it will cost you extra. Nobody manages your money for the kindness of their hearts. Several funds have performance fees. It's typically the high-water mark (HWM) fee for profits above reference index returns.

chollida1 6y ago
Just to be clear a high water mark isn't a hurdle rate in the sense the OP was talking about. In hedge fund land a high water mark means that if a fund loses money they won't take fees again until they've gotten back to their original high water mark. ie you invest at 100, they gain 10% after fees so your units are worth 110. The next year they lose 10% so your units are worth approx. 99. Now the high water mark is 110. Next year they make 5% so your units are worth approx. 104%. T his year the fund doesn't take performance fees as they haven't cleared their high water mark yet. Point being the high water mark is relative to their own fund and has nothing to do with the market or any other benchmark. If a fund only takes performance fees after a certain hurdle rate that is becoming more common but would be described by some other term.

bidirectional 6y ago

This is called a hurdle and many funds use them. Buffet's bet was against funds of funds which are basically indices tracking certain hedge funds, not hedge funds themselves.

CapriciousCptl 6y ago

Ironically Buffett started with exactly this over half a century ago-- setting a cumulative hurdle rate of 6%-- meaning he wouldn't take fees unless investors made at least 6%. He beat the Dow (S&P 500 wasn't really a thing during the Buffet Partnerships) every single year.

missedthecue 6y ago

Almost all hedge funds have a hurdle rate

pedrocr 6y ago

If Goldman had a way to guarantee returns above the market why would they sell that to anyone? Or put it another way, who is the sucker that is taking the other side of those Goldman trades to get returns guaranteed to be below market? Total market returns are zero sum.

Gustomaximus 6y ago
The why is access to additional capital.
jwally 6y ago
Say Goldman can beat the market by 20%. They sell you a fund that promises to beat it by 1%. The additional 19% return on YOUR MONEY they keep. You are guaranteed alpha at exactly 1%. Goldman makes fees and infinity ROI for taking risk. Win-Win.
- chii 6y ago
  > Say Goldman can beat the market by 20%. if they could do that, they could just keep that 20% and they'd be already ahead. Why do they need to pay you 1% for your money?!
  - fooker 6y ago
    >Why do they need to pay you 1% for your money Das Capital!
  - edanm 6y ago
    In general (not answering this specific case), a fund wants more money under management, because they get percentages of more money that way (they have more leverage). You might be assuming Goldman has infinite money - they don't. Here's how to think of this: Say I'm an investing wizard - I can generate 20% returns on any money invested. Scenario 1: I have 100k capital, which means after one year, I'll have 120k. I made 20%, but in practice that's 20k. Scenario 2: Now say I sell to you my wizarding ability by giving you 10% and keeping 10%. I'm giving you half the upside. However, you are a rich bank that invests 100m. I turn it after one year into 120m, give you half of that and keep half, so you've gotten 10m and I've gotten 10m. Now percentage-wise, obviously I'm ahead in scenario 1, but in real terms, obviously I prefer scenario 2 - I've gotten 10m dollars instead of 20k dollars. Btw in the real world, if I have to invest more money, my prowess goes down. So with 100k I can do 20%, with 1m I can do say 19%, etc. So what you'd expect to have happen is that more and more people will invest, because it's worth it to them, until eventually my abilities go down to just generic S&P level. Up to then, it's worth it for every extra investor to invest, because even if I'm only beating the market by 1%, that's a lot, but eventually I'm managing enough money such that I'm just rivaling the S&P. So from the outside, it looks like I'm not really doing anything special, but it was totally worth it for every investor until now.