Here’s a another little fact from The Snowball that I found interesting. When Warren Buffett set up his first investing partnerships where he agreed to manage other people’s money, he wanted a compensation agreement that was fair and equitable.
I got half the upside above a four percent threshold, and I took a quarter of the downside myself. So if I broke even, I lost money. And my obligation to pay back losses was not limited to my capital. It was unlimited.
The last part meant he could lose more money than he put actually invested into the partnership. He would cover a quarter of all losses from his partners, even if it meant selling his house or other assets. Now that is what I call a true alignment of interests.
Sure, half of the upside past 4% is a lot, but can you imagine any modern hedge fund agreeing to such a fee structure that would expose them to losses? Nope, they get “2+20″, which means 2% of assets no matter what plus 20% of profits, which really encourages them to just swing for the fences. If they implode (which many did recently), they simply pack up and open a new fund down the street.
It’s hard enough these days to find a mutual fund manager where a substantial part of their net worth is invested in the fund they manage.