British Virgin Islands: Long Live The King: Why Lebron James Helps Justify Performance Fees

Last Updated: 27 June 2016
Article by Philip Graham

Most Read Contributor in British Virgin Islands, July 2017

For those that are not aware, LeBron James just transcended his sport. Playing against a team that some have described as the best ever and down 3-1 in the Finals (a position that no other team in NBA history has ever come back from), he produced some of the greatest basketball the world has ever seen. Hell, some of the greatest sporting performances the world has ever seen.

He threw up numbers that are mind-boggling and yet he was far more than that. Leading a decidedly average supporting cast, there was something about this Cavaliers team that clearly just kept on believing in their superstar.

Because that's what he is.

One of the tired narratives that you regularly hear when discussing sport is why people who throw/kick/catch a ball for a living deserve to be paid such ridiculous sums of money.

Now there are a number of retorts to this (just ask any resident of Cleveland right now whether LeBron's US$24 million salary is deserved and frankly they'll open their wallets and hand over even more), but the one I'd like to personally focus on is the level of competition professional athletes go through to get to where they are. They are competing with hundreds of millions of others (in some sports, you could argue billions), all of whom want to play this game at the highest level, all of whom will give their blood, sweat and tears to get there and yet it is these chosen few that rise to the top. The very best of the best.

And yet.

There are certain athletes that when facing others at the very highest level can still make every other player in their sport look average. This shouldn't be possible and frankly it is super-human. When comic books are written about the likes of Superman, they are inspired by human beings who rise up and defy conceptual belief.

There is nothing more incredible than watching the likes of LeBron, Tiger Woods (pre the run-in with the tree), Usain Bolt, Lionel Messi, Serena Williams or Muhammad Ali simply dominate their sports and stand proudly as arguably the greatest collection of athletes humanity has pulled together in our 200,000 years on this planet1.

Can you really put a price on the value of someone that is better than the other 108 billion people who have walked the Earth?

Similar commentary is being widely heard in our own circles right now. The negative attitude to fee levels is at an all-time high in a macro-environment that is undoubtedly going to result in one of the worst years on record for the $2.9 trillion hedge fund industry. In a great article from Andrew Beer of Beachhead Capital Management2 in the FT, Mr Beer states the following:

"Twenty years ago, the "2 and 20" fee model made a lot of sense because most hedge funds were small. The 2 per cent management fee on a $10m fund covered the rent and paid for a hire or two.

The real money was made on the performance fees. Today, that $10m fund is $10bn and the fee structure is the same. The industry has matured, but the fee structure has not. This is a big problem for three reasons.

First, high management fees distort incentives.

For a $10bn fund, a 2 per cent management fee equates to $200m for the hedge fund company per year. Generously assume $25m in operating costs, and the manager still clears $175m.

The management fee is now a big, big profit centre. Instead of shooting the lights out, the manager's incentive is to keep the game going.

The solution is that, as funds grow, management fees should decline — and disproportionately for early investors. A sliding scale rewards early investors, who then have an incentive to remain invested and preserve their low-fee status.

Second, incentive fees without a hurdle — the level of return a fund must beat before it can charge additional fees — is pure giveaway.

Performance fees should provide incentives to outperform, not just show up. In 2013, investors paid billions in incentive fees to long-biased hedge funds simply because the markets were up. Incentive fees should be paid over a hurdle. Deliver alpha and the performance fee makes sense.

Third, align lock-ups with incentive fees."

There is no doubting that we at Harneys are seeing the imposition of a sliding scale of management fees based around increasing AUM more and more and that should be encouraged.

But for me, when managers earn performance fees (above a hurdle and high water mark of course) at any point in time, but especially in this current climate, they deserve every penny they earn. Looking back through the achievements of the likes of George Soros, David Tepper, Kenneth Griffin and John Paulson, you have to keep in mind that whilst these guys have earned vast fortunes from their profession, they have seen (and most importantly, acted upon) aspects of the economic climate that others have simply not picked up on, despite the vast majority of the data they rely on being publically available to everyone.

Now whilst these accomplishments are often much trickier for any of us mortals to understand as compared to a man putting a ball in a basket, that does not make them any less impressive; someone's magical deft touch with their foot is another person's mental leap to make the trade that others can't even envisage.

So here's to the super-humans we share our planet with, in whatever form we find them.

And maybe, just maybe, this X-Men thing isn't so fanciful after all.

Footnotes 

1. This list is clearly put up for very serious debate. Preferably with a beer in our hands.

2. http://www.ft.com/intl/cms/s/0/a83addb2-2cb9-11e6-bf8d-26294ad519fc.html#axzz4C5TjwGhK

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