Fund Manager Compensation, Inflation and Moral Hazard
April 1st, 2011In my day job at Spinoff & Reorg Profiles, it’s not every day I have a chance to report on a Zimbabwean spinoff. Yet conglomerate Meikles Africa Ltd (MIKM.L) this month completed the distribution of Kingdom Financial Holdings to its shareholders. Both will relist “soon,” says the parent.
Once listed, these two would seem excellent opportunities for a performance-compensated fund manager, if he were unabashedly sociopathic. Zimbabwe’s recent inflation rates, which reached 231 million percent in 2008, practically guaranteed nominal equity returns well over a thousand-to-one every year. Suppose the manager is compensated as a percentage of nominal Zimbabwean dollar returns. He simply puts 100% of assets into MIKM or its spinoff; shares go nowhere, or even fall in real terms; but they rise, say, a hundred thousand percent nominally; the manager collects a 20% override on the gain.
In effect, he transfers almost 20% of his partners’ wealth to himself every year.
This reductio ad absurdum illustrates a potential moral hazard in performance-based compensation under conditions of high price inflation. Investing to keep up with inflation is vastly easier than investing to beat it; thus, from a return-on-effort perspective, when inflation is high, the portfolio manager with a performance incentive and a fixed hurdle is well paid just to do the minimum, easily clearing the compensation hurdle without increasing his partners’ real wealth. Sometime in the next several years, we may have a chance to see what ensues under such conditions.
another mugabe triumph.
isn’t being an unabashedly sociopathic hedge fund manager the norm, not the exception?
hopefully the impending inflation will force fund managers to pursue the mike burry model.
Media reports notwithstanding, the hedgies I know are all do-gooder philanthropist types, to a man. If that’s just a cover, it’s a pretty elaborate one.
if they did not participate in philanthropy, i think that less people would feel good about paying someone to lose them money. if hedgies cared about aligning their interests with their investors, perhaps they’d move on from the 2/20 pay structure.
but nevermind the moral hazard inherent in that structure, they are do gooder philanthropists!
The guys I’m thinking of charge 0/25, just like the old Buffett Partnership. That alone goes a long way to align incentives. Except, as implied above, in the case of high inflation. Hurdle rates may need to be rethought under those conditions.
ah, touche.
i’m kind of surprised that real returns aren’t something already implied in measuring fund performance.
maybe it’d be hard to explain to investors an increase in a manager’s profit if positions nominally declined in a deflationary period?