Monday, October 6, 2014

The Mercedes of Fee Generators: A Look at a Hedge Fund-of-Fund

The Mercedes of Fee Generators:  A Look at a Hedge Fund-of-Fund

One of my loyal readers sent me a prospectus[1] for a hedge fund-of-funds managed by Ironwood Capital Management.  The fund’s goal is to generate capital appreciation while limiting year-to-year fluctuations.  This product isn’t a mutual fund.  While it’s registered with the SEC, it is restricted to “sophisticated investors.”   Here’s what caught my reader’s and my attention:

Member Transaction Expenses

Maximum Sales Charge                                                        3.00%
Early Repurchase Fee                                                          5.00%

Annual Expenses

Advisory Fee                                                                       1.20%
Account Servicing Fee                                                         0.75%
Other Expenses                                                                    0.27%
Acquired Fund Fees and Expenses                                      11.35%
Gross Annual Expenses                                                       13.57%

Less Fee Waiver and/or Expense Reimbursement               (0.27%)

Net Annual Expenses                                                          13.30%

This document is telling potential investors (they are called members because the investment is structured as a limited partnership) that if they invest, their broker may charge up to 3% of their initial investment, and that they’ll be charged another 5% if they want to get out of the product within the first twelve months.    The sales charge (also known as a front-end load) and repurchase fee aren’t unusual features of this type of offering.   The net annual expenses are mind-numbingly high at 13.3%.  In other words, if someone invests $50,000 (the minimum), $1,500 goes to a broker or financial advisor.  Thus, the starting investment is $48,500.  The manager is charging 1.2% per year on the average account balance to set strategy and select hedge funds.  There’s another 0.75% for incurred for servicing the account and 0.27% for other expenses such as accounting, legal and printing costs.  All of these expenses seem to be on the high side, but it’s the acquired fund fees and expenses that are breathtaking.


The acquired fund fees and expenses represent the estimate of the management fee, incentive fee, and other expenses charged by the underlying hedge funds, which total 11.35%.  For an investor paying the full sales charge, this means that the fund has to generate a gross annual return of about 14.9% for five years in order for the investor to break even.  In order for an investor to achieve an 8% return, the gross return would have to be about 23% per year.  According to the firm’s annual disclosure presentation, Ironwood has generated an average net return of 5.8% with an annual standard deviation of 12.9%.   These aren’t terrible results, but I’m positive I could have generated better returns with a similar risk profile utilizing a collection of exchange-traded funds.

No one can accuse Ironwood or any other fund-of-fund manager of failing to make lots of disclosures.  The prospectus lays out all the structure, expenses, and risks in great detail.  The manager files its holdings on a quarterly basis along with annual and semi-annual financial statements.  However, I doubt that most investors or their advisors actually wade through 60 or more pages of a prospectus or spend much time analyzing the other filings. 

Ironwood’s fund allows investors to own a small piece of some of the best-recognized names in the world of hedge funds, such as Citadel, D.E. Shaw, and Eton Park.[2]  This exposure probably makes investors feel sophisticated instead of fleeced even though the money managers are the only ones doing well by this fund.





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