Pabrai/Buffett partnership fee structure

[benhacker]

Do you care to share your results over this period?

 

My information is all public. You can find anything you need with Google.

[racemize]

Do you care to share your results over this period?

 

My information is all public. You can find anything you need with Google.

 

Since you may not be able to post it, I will (presuming I'm right):

http://www.remickcapital.com/perf.html

 

Out of curiosity, how are you allowed to post performance online?  Is it because you are an advisor and not running a fund?

[rohitc99]

Regarding questions about how those of us who started small have grown.  My AUM / client history is below (formed business in late '06) which I think is typical of a small RIA with only minimal / medium connections to wealth who lives far off the Street:

 

Ben

 

Hi ben

thanks for sharing ..very useful to someone like me who plans to go down the same path. the usual stories of 0 to 1Bn AUM in 2 years are very discouraging and makes you feel like it can never be done

 

[Philip Morris IV]

This is an interesting discussion.  I'm late here but will add from a past experience, and say the points Nate et al brought up about sales/marketing are fair.

 

I spent 3 years as a retail financial advisor before starting an RIA.  Their attitude is the total opposite - marketing is everything.  Advisors have elaborate systems to quantify their marketing efforts, like spreadsheets on how many calls, how many meetings, yes's/no's, etc. and spend a great deal of time both alone and in daily team meetings analyzing them.

 

As far as analyzing investments, most advisors are expected to know just a baseline level that's good enough for most people.  Anything beyond that is discouraged.  The prevailing attitude is that only big brokerage analysts are qualified to research stocks.  When I started thinking about leaving, I thought maybe it was just my firm, but it is not.  I frequent another forum for advisors from many different firms and the mentality is similar across the industry.

 

To an extent, many here represent one end of the spectrum and the retail investment business is the other end.  I think it's reasonable to say that one should find a balance.  For example, great performance can be a form of marketing, but you still have to work on your visibility.  You still have to get in front of new people on a regular basis, present yourself well, schmooze, close them, etc.  It is a skill like any other.  How you raise capital varies, but it's still an effort that needs attention.

 

I'm not 100% certain on this, but I believe Buffett went through this same realization shortly after forming his first partnership.  He had trouble raising capital, so he studied Dale Carnegie's work and organized seminars for him to meet investors and sell them on himself.  He probably spent a few years doing some serious marketing and facing his fair share of rejection early on (although those people probably regret turning him down!).

[benhacker]

Out of curiosity, how are you allowed to post performance online?  Is it because you are an advisor and not running a fund?

 

I'm not a lawyer, and I don't hire one either, so take this for what it is.

 

In layman's terms, I believe Funds in general have rules on putting themselves out as advisors because they are essentially selling private placements in companies (and LP for example).  Private placements have restrictions for obvious reasons.

 

Separate account guys (assuming they are registered with their State or the SEC) are registered advisors, and can present themselves as such.  there are restrictions are "marketing" but that does not (from what I understand) prevent you from fully disclosing facts about your business / advisory services as long as certain disclosures are met.  The State has never told me there is any issue with publishing performance results.  For this reason, I tend to be highly skeptical of any RIA who doesn't.

 

I believe there is no reason why I couldn't open an LP in conjunction with my SMAs as long as I disclose it... but for the LP, I believe it would be problematic in the base case to disclose *any* performance details about the LP.

 

So take this for what it is.  I'm not a lawyery type who reads all the regs in detail, I know there are some who have found interesting ways to get around some of these general guidelines, and I do know some people who have found a way around typical rules for LP / fund limitations (even ignoring the performance marketing aspects) such as # of clients, wealth of clients, registration, etc.  Basically what I'm saying is that after extensive research on these topics over the years and talking to many others in the field, I think there is a lot of grey area and nuance.

 

My basic answers for RIA / aspiring RIAs (in the US) -- Call your state regulator and ask what is needed.  They are at the end of the day your ultimate arbiter of what is "ok".  I'm reviewed every 3 years by the state or Oregon and I just do what they say to do.... if they don't have any problems with my website I don't change it (and I know they look at it).

 

Hope that helps.

 

Ben

[ageofsocrates]

Regarding questions about how those of us who started small have grown.  My AUM / client history is below (formed business in late '06) which I think is typical of a small RIA with only minimal / medium connections to wealth who lives far off the Street:

 

YE '07 - $0.31m / 11

YE '08 - $0.31m / 15

YE '09 - $1.06m / 19

YE '10 - $2.42m / 30

YE '11 - $3.25m / 34

YE '12 - $3.82m / 39

 

Probably will close out this year with $6-6.5m and 50+ clients.

 

For what it's worth, I think there are many ways to success, and they mostly depend on what you want / define as success.

 

I started at the urging of some friends, who persisted to harass me for several years after college.  They suggested to me my business model based on my concerns, which at the time were:

 

1) I liked investing, I don't like dealing with clients / running a business (I wouldn't describe myself as entrepreneurial)

2) I had a full time job, and I hated the idea of marketing financial services to get a size which would sustain itself

 

My friends just said to manage the assets of clients the same as my own, no exceptions, and just tell clients to take it or leave it.  They told me to setup shop with the expectation that clients wouldn't talk to me, and keep it that way.  Seemed reasonable to me, so that's what I did.

 

For those who think this is so hard, I can only say that "yes" it take a long time commitment... but I think it's simple (maybe not easy).  I would say that if you are managing your own money *and* you strongly believe you are exceptional at managing assets, I think the stretch to managing money isn't a big one.  So what if you don't make money for 5-7 years... what does that matter?  If you want a "job" that can generate high income immediately, well then I agree it sucks, but how many people really are doing this for that reason (maybe a lot, but I doubt it)? 

 

This is a job you can do on the side (obviously not ideal, but if you are managing your own money you likely are already doing that right?).  Also, as with almost any business, the value (NPV) of the business lies deeply out in the future cash flows, and I think if you think of this as creating a business (not really my focus, but it's certainly an aspect of what I do this) you have to think the same way.  Assuming you can do 2-3% above market after fees for 10 years (not 5) I can *guarantee* you that unless you are trying to hide, you will be found whether you doing any marketing at all.

 

For me, I have always done no marketing, just word of mouth, mostly because I truly believe that what I wrote above.  Your clients at the start aren't really what create the most business value (or value for clients themselves)... in the long term what creates value is a long run of above average performance coupled with clients who stick it out because they believe and understand what you are doing so they actually experience your above average performance (so many great investors fail this second test).  There is no value in tricking / marketing clients to join you because they will be the first to bail on you (whether you are doing well or not) for the smallest reasons.  They will then spread bad words about you and it won't do you any good - again, in the long run.  It's much better to get clients / assets only when they are a good match for your philosophy, and to be continually clear about what your strategy is so that over time you can create a clear and accurate honest representation of yourself and your business.  I believe genuine honesty coupled with performance (as well as clear speaking / presentation skills) are key to this business.  Marketing is not remotely required if you only care about terminal value as opposed to near term income.  The behavior of the money management business in general is clearly geared in the opposite way, and that is probably the biggest opportunity to those of us doing this on a small scale with a long time horizon.

 

When I started my plan was that I would have to do it as a side business until I had $4-5m (with my fee / cost structure that means about $45k in income) which has proven to be pretty accurate based on my personal / family expenses.  Also, I had the assumption that many clients would be on the fence until I had a 5-7 year track record because from I what I knew of psychology that is when a track record becomes "real" to most regular folks.  Both of these assumptions have held true generally from what I have seen.

 

Overall, I think I have experienced what could be described as typical business results for someone doing this solo without marketing.  I think I've had some lucky breaks getting some big clients, or maybe also having some higher net worth friends than others may have, but I also started right before the Great Recession (and my portfolio focus is on financials generally) so maybe it balances out.

 

Just my perspective, I appreciate others sharing their experience.  My comments above weren't meant to disagree or argue with anyone with a different perspective, I just wanted to share my own thoughts as a small data point.

 

Ben

 

Hi Benhacker.

 

Just a quick question. How many hours did you put in researching companies when you were working at a fulltime job?

[benhacker]

Just a quick question. How many hours did you put in researching companies when you were working at a fulltime job?

 

25-30 on average spending time on investing (message boards, K's, Q's, books, etc).  Some weeks more, some weeks less.

[shan]

Great discussion!

 

It will be great if someone could share what they do for tax accounting for the client's gains/losses in their funds?

 

I am planning to start my fund (limited partnership with GP as LLC) with Buffett/Pabrai style 6/20 fee structure. I am currently struggling with understanding how to account for the  taxes for different clients. I saw that some big funds maintain two types of book-keeping accounts for each client - 1.capital account (takes into account additions, withdrawals) , 2. Tax capital account (capital account + gains - losses)

 

PS: I am aware about the K-1 tax filing requirements, my question is more towards book-keeping for client taxes.

 

Thanks,

Shan

[slkiel]

As much as I like the Pabrai/Buffett incentive fee structure, there is a big piece unmentioned that makes it unworkable for small funds raising money from friends and family. In fact I did not even realize this when I started my fund in 2012. In order to charge performance fees in the U.S., a limited partner must be a qualified client. States have different rules on what asset size they must meet, but more states are adopting the new federal standard, which is $2 million not counting the value of the primary residence, or $1 million invested in the fund. This can be a huge problem if you choose to not take a management fee. For example, I currently have 10 limited partners, but only three of them are qualified clients.

 

This was a problem (for the general partner, at least) that didn't exist when Buffett had his fund. Additionally, when Pabrai launched his fund, the requirement was much lower. I believe it was the same as the accredited investor standard back then.

 

So, if your friends and family aren't qualified clients, and you choose the Pabrai/Buffett fee structure, you're going to be working for free whether you like or not until you can either get the investors up to that standard with the fund's performance, or you attract wealthier clients.

 

This is the sad part of these regulations, where in the name of protection, it reduces the ability of funds to bootstrap. At least for those who don't have wealthy friends and family. Though, clearly from the examples on this thread, many have powered through and done it anyway, whether they are rightly compensated for it in the beginning or not. I commend those of you that have done this, but it would be very difficult to do without an understanding spouse or some other income stream. 

[shan]

As much as I like the Pabrai/Buffett incentive fee structure, there is a big piece unmentioned that makes it unworkable for small funds raising money from friends and family. In fact I did not even realize this when I started my fund in 2012. In order to charge performance fees in the U.S., a limited partner must be a qualified client. States have different rules on what asset size they must meet, but more states are adopting the new federal standard, which is $2 million not counting the value of the primary residence, or $1 million invested in the fund. This can be a huge problem if you choose to not take a management fee. For example, I currently have 10 limited partners, but only three of them are qualified clients.

 

This was a problem (for the general partner, at least) that didn't exist when Buffett had his fund. Additionally, when Pabrai launched his fund, the requirement was much lower. I believe it was the same as the accredited investor standard back then.

 

So, if your friends and family aren't qualified clients, and you choose the Pabrai/Buffett fee structure, you're going to be working for free whether you like or not until you can either get the investors up to that standard with the fund's performance, or you attract wealthier clients.

 

This is the sad part of these regulations, where in the name of protection, it reduces the ability of funds to bootstrap. At least for those who don't have wealthy friends and family. Though, clearly from the examples on this thread, many have powered through and done it anyway, whether they are rightly compensated for it in the beginning or not. I commend those of you that have done this, but it would be very difficult to do without an understanding spouse or some other income stream. 

 

I checked the requirements on SEC recently and it seems that you are mentioning a 3©(7) fund. For a 3©(7), the requirement is qualified clients and the number of client is now 1999 (used to be 499).

 

But you can still do a 3©(1) fund with upto 99  accredited investors. The accredited definition is now 1M assets without residence or 200K per year income. In fact, you can have 35 non-accredited investors but then you cannot advertise freely as allowed by JOBS act.

 

Info with quick summary is here - http://online.barrons.com/article/SB50001424053111903591504577361903353035884.html and you can check SEC webpages for Dodd-Frank and JOBS act updates which will confirm the Barron's article.

[slkiel]

This is what I didn't fully understand until I started the fund. You are right about the accredited investor requirements. However, in order to charge performance fees, the LP has to also be a qualified client with the minimum asset requirements that I listed. So, for example, I have 10 investors. Three of them are qualified clients (assets of at least $2m or at least $1m in the fund). I can charge them performance/incentive fees. Eight of them are accredited investors. As a 3©1 fund I can have up to 35 non-accredited investors in the fund, so no problem on the two who are not accredited (other than higher liability potential from them). But, I cannot charge performance fees to the seven investors who are not qualified clients. 

 

The qualified client levels for sub $100m (I believe) funds are defined by the state rules, which are different across states. However, there is a model law movement to revise the standards in the states to match the SEC definition. Many states have done this already, and others are following suit. For all the states I've looked at who have not adopted the $2m threshold, they still have an old $1.5m level.

 

For 3©(7) funds, I believe all of the LPs must be qualified clients.

[Redskin212]

slkiel

 

If I understand correctly, in order to charge a performance fee partners in your fund must be both an accredited investor and a qualified client?

 

Redskin

[slkiel]

All qualified clients are accredited investors.

[shan]

This is what I didn't fully understand until I started the fund. You are right about the accredited investor requirements. However, in order to charge performance fees, the LP has to also be a qualified client with the minimum asset requirements that I listed. So, for example, I have 10 investors. Three of them are qualified clients (assets of at least $2m or at least $1m in the fund). I can charge them performance/incentive fees. Eight of them are accredited investors. As a 3©1 fund I can have up to 35 non-accredited investors in the fund, so no problem on the two who are not accredited (other than higher liability potential from them). But, I cannot charge performance fees to the seven investors who are not qualified clients. 

 

The qualified client levels for sub $100m (I believe) funds are defined by the state rules, which are different across states. However, there is a model law movement to revise the standards in the states to match the SEC definition. Many states have done this already, and others are following suit. For all the states I've looked at who have not adopted the $2m threshold, they still have an old $1.5m level.

 

For 3©(7) funds, I believe all of the LPs must be qualified clients.

 

I don't fully understand this yet.

 

1. Do you where the requirement for performance fees to be applied to only qualified clients is given? Is that part of 506 code?

 

2. Also did you try to register as an exempt registered investment advisor?  For example, California allows exempt registered investment advisor criteria to be the same as SEC. See section "New Exemptions" here - http://www.reedsmith.com/New-California-Exemption-for-Investment-Advisers-to-Private-Funds-09-19-2012/

 

3. Can you clarify what you mean by the $2M threshold?

 

4. If you don't get exemption from state, it only means that you have to be a registered investment adviser there. Why does it affect the charging of performance fees?

 

[Parsad]

slkiel

 

If I understand correctly, in order to charge a performance fee partners in your fund must be both an accredited investor and a qualified client?

 

Redskin

 

Yup, if you charge an incentive fee, partners need to be qualified.  Cheers!

[shan]

I think I found most of the answers here - http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171487308#.Ut4WU2TTk10

 

This sucks for people who didn't start their fund before 2012 :(

 

It says cannot charge performance fees to clients other than "qualified clients". So charging management fee (1-2%) is allowed?

 

[abitofvalue]

Phenomenal discussion in this thread.  thanks a lot.

 

How did a lot of you get started? Did you just take your personal account trading history and use that as your track record?  I have had a few friends ask me to manage money for them but have been deferring till I can figure out how to make this work beyond the initial few friends.  I suspect a few of you may have been in a similar position so any advice on how to think about it beyond initial clients?

 

In terms of soliciting new clients when you were starting out and asked someone to invest with you did your personal trading account sit-in as a part of your track record?  I presume a friend of a friend would want some information before investing with you.

 

Also, how did you guys first set-up? the initial costs seem pretty daunting.  anything you wish you had done differently that we could could benefit from?

 

I am amazed by the number of people who started with sub $1mm AUM.  Would love to learn more about how to do this.

[merkhet]

I am amazed by the number of people who started with sub $1mm AUM.  Would love to learn more about how to do this.

 

My answer was to suffer for a while and use my savings.

[slkiel]

I am amazed by the number of people who started with sub $1mm AUM.  Would love to learn more about how to do this.

 

I think the smartest way to do it is the way Pabrai did (and Buffett for that matter). He made a bunch of money personally in the market over several years, and then was able to start with a decent amount because of that. It seems like people came to Pabrai. The problem with starting very small (and I'm one of those that did), is that you are desperate to raise money in the beginning. You need to be careful that that doesn't affect your portfolio management decisions. You also don't want to spend too much of your time trying to raise money, when you should be doing research.

 

Even if you're young, if you're really as good as you think you are, you should be able to grow your own money to a few hundred thousand. You may need to really scrimp and save to start though. At that point, you should be able to get started and there would likely be some friends and family that would know about you and kick in something as well, even if as small as $10k.

 

Once you get going, as long as perform, random acquaintances will get interested. You just need to keep putting yourself out there. I think for most of us who have funds, it took longer than we expected. But, if you perform, you'll make it eventually if you are committed and your funds will mushroom at some point. You'll also learn more in your first year running the fund than you would have ever expected.

[abitofvalue]

Thanks guys this is very helpful.  On building / marketing your track record -  I have seen a few of Buffett's quotes about getting an audited track record as soon as possible.  Think he said that would be the one thing he would do differently (get an audited track record sooner)

 

What exactly does this mean - is it just as it sounds go to a CPA with your brokerage statements etc? I assume you need to have a certain amount of assets for this to be worthwhile.  Just wondering how far you went back - think I saw an interview with Guy Spier about this where he said he thinks of his track record as including his personal record from the day he started trading.  Did you guys do that too?  I assume you started off with your own personal trading account and didn't start off with an account in the name of your business.  Do you use your personal trading history for this?

[Ham Hockers]

Thanks guys this is very helpful.  On building / marketing your track record -  I have seen a few of Buffett's quotes about getting an audited track record as soon as possible.  Think he said that would be the one thing he would do differently (get an audited track record sooner)

 

What exactly does this mean - is it just as it sounds go to a CPA with your brokerage statements etc? I assume you need to have a certain amount of assets for this to be worthwhile.  Just wondering how far you went back - think I saw an interview with Guy Spier about this where he said he thinks of his track record as including his personal record from the day he started trading.  Did you guys do that too?  I assume you started off with your own personal trading account and didn't start off with an account in the name of your business.  Do you use your personal trading history for this?

 

This doesn't answer your question, but if you're going to use your personal trading history as part of your track record, I'd recommend that you monitor your performance exactly as you would as a fund, even before going to get it audited.  For the most part, this means that taking the numbers your brokerage firm gives you isn't good enough.

[DoddDisciple]

I wasn't aware of the recent 2012 designation of accredited vs qualified investors, but overall it just seems to make it unlikely for anyone to want to start a fund from scratch, especially something more eclectic.

 

With accredited investors, unless they're supplying a huge amount of money to your fund, you can only charge a 2% management fee, regardless of results. So to make $70k, not factoring in all supplemental business and advisory costs, you'd have to raise $3.5M. There's not much reason to do anything beyond just sticking the money in something plain and marketing for more money after that, since you're not going to get any of the upside.

 

To actually get a performance fee, you have to have qualified investors with even higher net worth requirements, and the performance fee is limited to 20%. On the same $3.5M, let's say you do 20% and take 20% of the upside beyond 5%. You're only talking about $100k here, which is a great salary, but again, you have all these other fees and it's not guaranteed.

 

I can now see why success in the investment field is 99% based on the connections you have.

[oddballstocks]

I wasn't aware of the recent 2012 designation of accredited vs qualified investors, but overall it just seems to make it unlikely for anyone to want to start a fund from scratch, especially something more eclectic.

 

With accredited investors, unless they're supplying a huge amount of money to your fund, you can only charge a 2% management fee, regardless of results. So to make $70k, not factoring in all supplemental business and advisory costs, you'd have to raise $3.5M. There's not much reason to do anything beyond just sticking the money in something plain and marketing for more money after that, since you're not going to get any of the upside.

 

To actually get a performance fee, you have to have qualified investors with even higher net worth requirements, and the performance fee is limited to 20%. On the same $3.5M, let's say you do 20% and take 20% of the upside beyond 5%. You're only talking about $100k here, which is a great salary, but again, you have all these other fees and it's not guaranteed.

 

I can now see why success in the investment field is 99% based on the connections you have.

 

Connections and AUM.  When I see this math I wonder why someone's taking the risk of managing money?  Most people doing this can make the same amount doing the same thing for someone else with zero risk.  There is zero liability risk etc.

 

Unless you can raise a substantial amount of capital, or you're doing it on the side for some spare pocket change the economics are tough.

 

On the other hand I know someone who opened a RIA.  They are managing any and all capital.  If a retiree wants them to manage their 401k they have a strategy for it.  If someone wants a value strategy they have that as well.  They aren't AUM constrained, I like that approach a lot.

[DoddDisciple]

I wasn't aware of the recent 2012 designation of accredited vs qualified investors, but overall it just seems to make it unlikely for anyone to want to start a fund from scratch, especially something more eclectic.

 

With accredited investors, unless they're supplying a huge amount of money to your fund, you can only charge a 2% management fee, regardless of results. So to make $70k, not factoring in all supplemental business and advisory costs, you'd have to raise $3.5M. There's not much reason to do anything beyond just sticking the money in something plain and marketing for more money after that, since you're not going to get any of the upside.

 

To actually get a performance fee, you have to have qualified investors with even higher net worth requirements, and the performance fee is limited to 20%. On the same $3.5M, let's say you do 20% and take 20% of the upside beyond 5%. You're only talking about $100k here, which is a great salary, but again, you have all these other fees and it's not guaranteed.

 

I can now see why success in the investment field is 99% based on the connections you have.

 

Connections and AUM.  When I see this math I wonder why someone's taking the risk of managing money?  Most people doing this can make the same amount doing the same thing for someone else with zero risk.  There is zero liability risk etc.

 

Unless you can raise a substantial amount of capital, or you're doing it on the side for some spare pocket change the economics are tough.

 

On the other hand I know someone who opened a RIA.  They are managing any and all capital.  If a retiree wants them to manage their 401k they have a strategy for it.  If someone wants a value strategy they have that as well.  They aren't AUM constrained, I like that approach a lot.

 

Yeah, I remembered your post on here when I found this out. I was looking to consolidate some family accounts at IB and operating them pro bono, but unlike it the past when I was very explicit in my questions and was told one thing, when it finally got to opening the accounts, what I was told was possible, wasn't, and I was just curious and looked at RIAs some.

 

The economics make no sense to those without connections or those with large AUM. You couldn't just get a few people today together and offer the same Buffett partnership scheme. If I'm reading this right, you can't get 5 people to pitch in $100k each and take a performance fee. I can see why innovation is in such short supply.

 

In regards to the RIA you know, if you spend a few hours with each and charge a fixed fee or management fee, I can see it working, but then of course, you're almost in the marketing business instead of the investing business. Then again, most people aren't willing to just pick up a book to figure out how to invest the money themselves (index funds, etc.), so there is a market for it.

[bookie71]

"The economics make no sense to those without connections or those with large AUM. You couldn't just get a few people today together and offer the same Buffett partnership scheme. If I'm reading this right, you can't get 5 people to pitch in $100k each and take a performance fee. I can see why innovation is in such short supply."

.

BUT 100,000 back then is equivalent to how many million now?