Cliff Asness and Matt Levine have smart articles critiquing the article in the NY Times about hedge fund manager pay in 2014. Cliff and Matt note that the NY Times article is excessively critical and intentionally paints the fund managers in a negative light. Specifically, much of the income generated from these managers is from their own capital appreciation as opposed to high fees. But I think the Times is making a fair point to some degree.
Asness and Levine argue that the Times piece is misleading because they imply that the income earned from hedge funds is unjustified. But both Levine and Asness note that the majority of this income comes from assets that are already invested in the funds. That is, it’s just their personal capital that is growing. This is true except that much of the 2014 income is likely due to exoribitant fees charged in past years. Most hedge fund managers don’t just wake up with a pile of personal money to invest. They raise funds, establish a track record and become wealthy by charging high fees. And naturally, their personal stake in the fund grows as their fee income grows and their personal stake grows. So yes, that 2014 income is partly the result of a consistent history of high fees.
I think the NY Times is making a more important point though. Here’s the key line in the Times article:
Their influence is growing beyond the industry and Wall Street. They lobby in Washington, donate to political campaigns nationwide, and can pick their advisers from a pool of former central bankers.
As I’ve argued before, we’re all active investors. We all deviate from global cap weighting and that means some of us will underperform and others will outperform global cap weighting. So there have to be some active investors who make smarter and more efficient asset allocation decisions than others. This is a simple reality of asset allocation. So, there’s real value in financiers who can intelligently allocate capital. But I guess the question is whether we overvalue these managers? After all, according to their incomes, our society thinks that managing a hedge fund is among the most valuable things that can be done.
I don’t know if that’s right or not. I am inclined to argue that asset managers who charge high fees promising to be able to “beat the market” are making a promise they likely can’t continuously deliver on. Then again, in a country that has become increasingly dependent on the growth in financial asset wealth there’s a very sound argument to be made that those who can prudently grow and protect that wealth are worth a sizable chunk of that wealth. I guess I think that good wealth managers are quite valuable. But I also think we likely overvalue them as a society and that will likely get rectified in the coming decades as investment management fees continue to decline.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.