Investment fee shocker

An analysis of hedge funds’ “two and twenty” fee structure shows that hedge fund managers enjoy far higher returns than their investors over an extended period.

Two and twenty – or 2 and 20 – refers to a popular hedge fund compensation structure consisting of management and performance fees.

2% represents the management fee for total assets under management, and the 20% performance fee is charged on the profits that the hedge fund generates, often beyond a minimum threshold.

To analyse the impact of the “two and twenty” fee structure on an investment, Daily Investors looked at a 40-year investment in Berkshire Hathaway.

Berkshire Hathaway is Warren Buffet’s investment holding company headquartered in Nebraska, USA.

It was formed in 1955 through the merger of two Massachusetts textile firms – Hathaway Manufacturing and Berkshire Cotton Manufacturing.

In 1965 Warren Buffet led an investment group that took control of the company, making him the CEO.

Berkshire Hathaway was to identify struggling companies with growth potential, acquire them at a discount, and help them back on their feet.

The company was listed on the New York Stock Exchange in 1980 for $290 per share. Today, a Berkshire Hathaway class A share costs $422,100.

Under Buffett, the company has become the poster child for successful investing and rewarded its investors handsomely over the years.

A $100 investment in Berkshire Hathaway in 1980 when it was listed on the NYSE would be worth $160,764 today. It translates to an average annual growth rate of 19.82%.

Fund managers are the big winners

To assess the impact of management and performance fees on an investment, Daily Investor looked at the impact if Berkshire Hathaway was a hedge fund with a two and twenty structure.

For this analysis, we made a few assumptions:

• There is a 2% management fee and a 20% performance fee without any threshold.
• The performance fee is subject to a high watermark – a clause preventing fees paid on prior gains.
• The hedge fund manager took all the fees received and invested them into Berkshire Hathaway stock.

The results revealed that the $100 investment in Berkshire Hathaway in 1980, with hedge fund fees, would only be worth $27,581 today. The hedge fund manager would have $133,182.

It means the fund manager would have made 382% more from the $100 investment than the investor.

The chart below shows how the investor and fund manager’s portions grew over time.