SMA Conflict of Interest

[porcupine]

...

I was thinking about avoiding the possibility of front running by buying / selling first in the fund but was happy to hear this is industry standard. If anyone can link to the CFA document that mentions that standard that would be extremely helpful.

...

https://www.cfainstitute.org/-/media/documents/study-session/2018-l1-readings.ashx?la=en&hash=CF0C95241ECE0CB2F0A4F70F94D6CBA5E3E0FB00

Section VI: Conflicts of interest    B. Priority of transactions

http://www.portfoliomanagement.org/wp-content/uploads/2011/04/CFA-code.pdf

Section C: Trading  2. Priority

 

PTSD just kicked in when I saw "Study Session 1 - Ethical and Professional Standards". Still have nightmares about this stuff.

[oddballstocks]

Why is it bad to invest in indexes personally?

 

Serves two purposes:

1) You aren't front running clients

2) Your time is focused on client trades, not your own

 

Ultimately if you do well the majority of your wealth will come from returns for clients, which is how it should be.  You're on a good path.

[DeepValuePlay]

Why is it bad to invest in indexes personally?

 

Serves two purposes:

1) You aren't front running clients

2) Your time is focused on client trades, not your own

 

Ultimately if you do well the majority of your wealth will come from returns for clients, which is how it should be.  You're on a good path.

 

If one believes in his ability to beat the indices over a long period of time he would want to invest his own money that way. Also LPs would want to know you eat your own cooking. I just don't understand how can someone want to put their money in an index unless they don't believe in their product.

 

That said, the product for most of the investment world sucks and it could make sense to index in your PA, but that means exactly that - you don't believe in the product your selling.

 

If one understands compounding and believes in his ability then he should throw indexing out the window.

 

That is just my opinion.

[DeepValuePlay]

Also if you're an investor rather than a trader, you actually trade in less than 1% of the time whereas the rest of the time is spent researching.

[oddballstocks]

Why is it bad to invest in indexes personally?

 

Serves two purposes:

1) You aren't front running clients

2) Your time is focused on client trades, not your own

 

Ultimately if you do well the majority of your wealth will come from returns for clients, which is how it should be.  You're on a good path.

 

If one believes in his ability to beat the indices over a long period of time he would want to invest his own money that way. Also LPs would want to know you eat your own cooking. I just don't understand how can someone want to put their money in an index unless they don't believe in their product.

 

That said, the product for most of the investment world sucks and it could make sense to index in your PA, but that means exactly that - you don't believe in the product your selling.

 

If one understands compounding and believes in his ability then he should throw indexing out the window.

 

That is just my opinion.

 

Sure, 100% of hedge fund managers believe they can outperform, but few actually do.  Maybe the product you sell to investors is different than what you need yourself.

 

But consider this. Maybe this is someone with a $1m portfolio (unlikely, but whatever, simple numbers).  Market does 10% over the long term, they believe they can do 14%, which after 2/20 is about a 11% return for investors.  So they beat the market.

 

If this person can do 14% on their funds in 10 years they'll have: $3.7m.

 

Let's say they start with $15m in assets.  If we have steady 14% gains a year in ten years the fund will be $38m in AUM.  They will make $5m in 2% fees, and $6.8m in their 20% cut.  Overall they'd earn $11.8m in a decade, or roughly 3x what they'd earn investing their own account.

 

This is why hedge funds are lucrative.  That 11.8m in earnings off the $15m base are from $0.  To earn the same thing investing you'd have to have 400% gains a year assuming you started with $1, and with this you start with $0.

 

Why would you waste any time investing for 14% when you can earn 400% returns (based on the above math) by managing someone else's money?  This is also why a hedge fund is lucrative if it merely matches the market.  You're harvesting insane fees.

 

[DeepValuePlay]

Why is it bad to invest in indexes personally?

 

Serves two purposes:

1) You aren't front running clients

2) Your time is focused on client trades, not your own

 

Ultimately if you do well the majority of your wealth will come from returns for clients, which is how it should be.  You're on a good path.

 

If one believes in his ability to beat the indices over a long period of time he would want to invest his own money that way. Also LPs would want to know you eat your own cooking. I just don't understand how can someone want to put their money in an index unless they don't believe in their product.

 

That said, the product for most of the investment world sucks and it could make sense to index in your PA, but that means exactly that - you don't believe in the product your selling.

 

If one understands compounding and believes in his ability then he should throw indexing out the window.

 

That is just my opinion.

 

Sure, 100% of hedge fund managers believe they can outperform, but few actually do.  Maybe the product you sell to investors is different than what you need yourself.

 

But consider this. Maybe this is someone with a $1m portfolio (unlikely, but whatever, simple numbers).  Market does 10% over the long term, they believe they can do 14%, which after 2/20 is about a 11% return for investors.  So they beat the market.

 

If this person can do 14% on their funds in 10 years they'll have: $3.7m.

 

Let's say they start with $15m in assets.  If we have steady 14% gains a year in ten years the fund will be $38m in AUM.  They will make $5m in 2% fees, and $6.8m in their 20% cut.  Overall they'd earn $11.8m in a decade, or roughly 3x what they'd earn investing their own account.

 

This is why hedge funds are lucrative.  That 11.8m in earnings off the $15m base are from $0.  To earn the same thing investing you'd have to have 400% gains a year assuming you started with $1, and with this you start with $0.

 

Why would you waste any time investing for 14% when you can earn 400% returns (based on the above math) by managing someone else's money?  This is also why a hedge fund is lucrative if it merely matches the market.  You're harvesting insane fees.

 

I am not in the fees harvesting business. My fund actually has no management fees and only incentive fees over a certain hurdle. Is there potential to make more money with the fund than with my PA - yes. However, I wouldn't invest one cent in a fund whose owner doesn't share my risk with his own money. No one in their right mind will.

 

Now, there are some exceptions - if you specialize in something very unique that wouldn't be appropriate as an entire portfolio (a fund specializing on short ideas for example) then I can see the manager diversify with additional investments. But with long only equity fund such the one I have - of course I'll invest in the ideas I work so hard to find.

[DW1234]

Isn't having the right incentives as a fund manager the most important thing? I obviously wouldn't want my fund manager to index his own money, but I wouldn't even want him to buy something without himself also buying it at the same time. If there's a scenario where the LP's end up owning a certain stock and the manager has a 0% allocation that would be very far from optimal.

 

By getting the incentives right, you don't have to trust your manager to constantly do the ethical thing against his own (v human) profit motive. A couple examples if the managers portfolio differs from LP portfolio:

 

- Less time investment in his smaller / missed positions.

- Smaller or 0% positions mean he has cash which he presumably wants to invest, so he might add to existing holdings or even new holdings. Which creates new warped incentives.

 

Essentially, I think the gain in EV of being the first to buy and the first to sell as an LP, is offset by the loss in EV of incompatible incentives.

[Guest oakwood42]

I think the CFA Institute may have some guidance on this topic and could be a useful reference for you.

[Guest oakwood42]

...

I was thinking about avoiding the possibility of front running by buying / selling first in the fund but was happy to hear this is industry standard. If anyone can link to the CFA document that mentions that standard that would be extremely helpful.

...

https://www.cfainstitute.org/-/media/documents/study-session/2018-l1-readings.ashx?la=en&hash=CF0C95241ECE0CB2F0A4F70F94D6CBA5E3E0FB00

Section VI: Conflicts of interest    B. Priority of transactions

http://www.portfoliomanagement.org/wp-content/uploads/2011/04/CFA-code.pdf

Section C: Trading  2. Priority

 

Nevermind +1