One response to “Perfectly aligned interests?”

  1. Rolf,

    I would argue that the fund manager objective is to maximise the NPV of future performance fees. This NPV is significantly more relevant than the performance on her own investment in the fund. Assuming AUM of 50mio and a target return of 10%, the gross profit is 5mio and the performance fee is 1mio. With a discount rate of 10%, the NPV equals 10mio, which is exceed the mere 0.5mio which she has invested in the fund. By maximising the performance fee, she maximise the investors’ performance.

    To pursue this exercise, she must focus on her area of expertise:
    a. If she only has stock selection capabilities, she should concentrate on pure alpha strategies and maintain a 0% net exposure.
    b. If she wants to offer some market exposure with downside protection, she will replicate the exposure of a call option, thus maintain a 50% market exposure (= delta of call option).

    I would further argue that a 0% net exposure is the preferred allocation, because investors can gain their target allocation, e.g. 100% in equities, by buying futures and this without paying performance fees.