The Investment Scientist

Posts Tagged ‘hedge fund

These are Warren Buffet’s own words. As usual, they are as humorous as insightful.

“In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd. For those innocent of this arrangement, let me explain: it’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you a bundle – and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide.

“…The inexorable math of this grotesque arrangement is certain to make the Gotrocks family poorer over time than it would have been had it never heard of these hyper-helpers. Even so, the 2-and-20 action spreads. Its effects bring to mind the old adage: When someone with experience proposes a deal to someone with money, too often the fellow with money ends up with the experience, and the fellow with experience ends up with the money

“They are the cancer of the institutional investment world.” – David Swensen

Would you consider forming a partnership with someone you don’t know, in which you would contribute the money and that someone would conduct a business that you don’t understand, and do the accounting as well?

Most business owners would respond with a resounding “No!” The reason is obvious: such an arrangement is the surest way to lose money.

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Avoid conflicts of interest.” – David Swensen, Yale Endowment CIO.

Jose is the head of a ultra high-net-worth family. He has a number of accounts with Merrill Lynch (ML), the storied brokerage firm that paid their senior executives $4 billion in bonuses last year. Three of his accounts lost a great deal of money, not due to the market crash but to conflicts of interest.

Double dealing in Treasury

Jose has a Treasury account where his ML wealth manager[picture of double dealing, enable image to view] purchases Treasury bills, notes and bonds for him. Last year was a great year for Treasury securities – the market turmoil caused investors to flock to them, driving prices up more than 10%. Jose’s account, however, lost 3%. How could this happen? Conflicts of interest. ML is a primary dealer in the Treasury market. They buy Treasury securities and resell them to their customers at a markup. It looks like the markup is so high it takes away all the customer profit.

Churning stocks

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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