Illustration: Aïda Amer/Axios
Hedge funds get paid a lot for the privilege of making you money (if you’re rich enough for the minimum investment, that is). But it’s not easy — most funds don’t even beat the S&P 500 index in most years.
Driving the news: Melvin Capital, the hedge fund run by Gabe Plotkin, was hit by catastrophic losses at the hand of meme stock mania in January 2021. Plotkin tried to revamp the fund and fee structure last week, which didn’t go over too well with some investors, the New York Post reported.
The big picture: The fund’s plight highlights the structural challenges built in to running hedge funds.
- How it works: Hedge funds usually charge a variation of what's known as “2-and-20” — they charge an annual management fee, usually around 2% of assets under management (AUM), then take a 20% or so cut of profits.
- Typically a fund that’s in the red has to claw its way back to a “high-water mark” — or make investors whole on their losses — before it can start collecting the performance fees again. Them’s the rules.
- The deeper the hole, the harder it is to hit the high-water mark. That means staff hopes for bonuses may go up in smoke even if the go-forward performance is good — unless founders spring for bonuses themselves.
State of play: Melvin is down about 52% since the beginning of last year.
- It came up with a simple, yet audacious, plan: It would just start over — and abolish high-water marks.
- It told investors last week that it would shrink the fund, and re-institute performance fees, the WSJ reported. Investors were welcome to take their money and exit, or stay on in the smaller fund.
- That's an unusual ask, a hedge fund manager tells Axios. Typically, when faced with such a deep hole, funds are more likely to shut down — though the managers may later on try to raise new ones.
The intrigue: Over the weekend, Melvin walked it back.
- Plotkin apologized to his investors in a letter, calling the plan "tone deaf," the Post reported.
- "We recognize now that we focused on future returns and team continuity without sufficient consideration of your investment losses," he wrote.
Melvin does have some clout: It's produced enviable returns in the past, gaining over 40% (after fees) in four of the six years before 2021, a source familiar with the firm tells Axios.
- Plotkin says he'll propose something new in a few weeks, after consulting with more investors.
The bottom line: So far, Melvin hasn't had any departures from its core investing team since January 2021, the source says. Whatever the new structure ultimately looks like may have some sway over whether or not that continues.