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Principles of finance ah la shmoop up the fee structure

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of funds Fee fi Foh fum We interrupt this epic

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story to bring you a bunch of fancy terms Venture

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capital private equity growth capital hedge funds mutual funds Well

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what do they mean The basic idea is that investors

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give these people money to make more money Bigger fatter

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more er each of the above flavors is just a

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different investing style in which to make that money each

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investing style And each fund features its own unique set

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of structures and or fees That's the money that you

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the investor pay the money managers to go make you

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more money but okay first thing's first it all starts

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with a big bag of money Say a doctor opened

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a chain of exam clinics and she ended up owning

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the real estate under those clinics And then a decade

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or so later she sold the whole thing for eighty

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million dollars when she was still young enough to enjoy

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her winnings after tax that eighty million dollars in the

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blue state in which she lived became fifty million bucks

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Well she bought a nice home A small ranch a

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small jet and had twenty million dollars left over to

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invest Well half of that money went to a nice

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conservative dividend loving mutual fund The other half went to

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spice spice or alternative investments That's what those things are

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the fancy names we gave you at the beginning here

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they're any of the not mutual or not index fund

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flavors those air vehicles through which rich people invest what's

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the difference Well we'll start with the fees that the

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managers charge people you know like the good doctor of

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a fee structure in these kinds of funds is vastly

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different among the asset classes and vastly more expensive like

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you can expect to pay And one percent a year

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for a mutual fund maybe half a percent a year

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for an index fund while the venture private equity hedge

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funds those guys are ten to one hundred times that

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price Why Well in theory they make a lot more

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money in practice They don't So here we go The

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most common fee structure is what's called a two and

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twenty fee structure and that exists in pretty much all

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hedge funds So given hedge fund has ah billion dollars

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Under management they take two percent a year twenty million

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dollars for the pleasure of just managing the money That's

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If they break even they start with a billion dollars

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and then they make two percent on their money At

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the end of the year they have a billion dollars

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That two percent that they made all went to them

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The money managers to keep is their fees They don't

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get rich on that two percent and it costs a

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lot of money to employ lawyers and secretaries and auditors

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and send out those fancy beautiful lambskin mailers and all

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the other crap They have to file with the sec

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and trading stations and on and on and on all

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that costs money and that's it two percent covers But

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then if they have a great year like they're up

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fifty percent that billion dollars goes to a billion five

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Well then after they paid their two percent that's ah

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you know we'll throw that in there as a forget

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it because it makes the math harder Here we have

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five hundred million dollars in profits While that hedge fund

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the twenties twenty percent of profits they keep twenty percent

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Of that five hundred million or one hundred million dollars

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that's what their take is so you the investor or

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or at least your fund ends up being worth a

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billion four not a billion five when they clip their

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coupon for their fees and most clipped them quarterly or

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thereabouts anyway That's how it works So when you hear

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two and twenty that's what it means in the venture

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capital elite in silicon valley make two and thirty meaning

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they take to present management fee and thirty percent of

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profits So yeah it's just crazy Expensive yet when you

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compared with the mutual fund at one percent and an

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index fund and a third of a percent and the

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reality is there's no such thing as a venture capital

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fund for example there's a half a dozen maybe a

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dozen who are really good and produce good returns for

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investors year after year But then there's like a thousand

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who suck But everyone wants to buy a lottery ticket

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and people spend a lot of money buying lottery tickets

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Real world an actual lottery tickets Why wouldn't rich people

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be the same You're a doctor who made all your

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money Probing your fingers into people's private places why would

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you know anything about finance particularly venture capital which is

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an arcane random difficult to understand highly technical technological area

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of the world But you like lottery tickets You like

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jets and love Hearing stories about the founders of google

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love buying islands Ex army votes to land their planes

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on stuff like that So why not roll the dice

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right Yeah it's Great until you lose all your money

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Let's dig into this venture firm thing than as a

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deeper example Here that doctor are friendly prober gives five

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million dollars to ah to in twenty five venture firms

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that's like a middle tier venture firm which turns it

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into a ten point seven million dollars a seven years

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later Five in ten point seven Well the firm clips

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a two percent per year fee from her five million

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dollars that as she is paying them one hundred thousand

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dollars a year to manage her five million So in

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the beginning of the fund or a five million dollar

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value is slowly destroyed Its worth four point nine million

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after year one if no investments are made and then

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they make a few and while they pray a lot

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and then they get lucky and they find a winner

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which pulls up the whole fund worth double Well in

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the process of those seven years to manage her five

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million dollars she paid them yes Seven hundred thousand dollars

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in guaranteed fees And then when the firm showed ten

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point seven million dollars in net gains well after subtracting

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the seven hundred thousand dollars in fees the original investment

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of five million dollars yeah there was five million left

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for attribution to carry or profit participation Will the fund

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was set off is a two and twenty five here

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So the general partners keep twenty five percent of the

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five million in profits or one point two Five million

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dollars as their quote incentive to work hard bonus So

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the doctor put in five million She made a twelve

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percent per year return on her investment Slightly better than

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an average s and p five hundred run With dividends

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reinvested she was lucky to be in the top ten

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percent performing venture capital fund Yes that's what the top

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ten percent does not very impressive And in the course

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Of those seven years on a five million dollar investment

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she paid the firm one point Two Five million dollars

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in kerry lost seven hundred thousand dollars or about one

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point nine Five million dollars in fees Sound a bit

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steve to you and this was a top ten percent

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performer Most venture funds still collect the fees but don't

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even return capital invested That is the expected case would

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be for the doc put in five million bucks and

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after seven years and i get about three point eight

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million dollars back if that be the median return So

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why on earth would anyone then be an investor in

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the venture capital business lottery tickets every now and then

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there's a fund that turns fifty or a hundred times 00:06:22.433 --> [endTime] capital maybe more Rich people love them some lotteries

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