Just after announcing plans to re-institute performance fees, failing hedge fund Melvin Capital has backtracked. From the Financial Times:
The US-based firm, which lost 53 per cent in January last year after betting against retail investor favourite GameStop, had written to investors only last week with plans to remove a so-called high-water mark, which stops a fund charging performance fees until losses have been recovered.
But within a matter of days, after receiving “candid” feedback from some investors, founder Gabe Plotkin has admitted he was “initially tone deaf”.
After being shellacked last January, Melvin was down 39% for 2021. It lost another 21% in the first quarter of this year.
That puts the fund down approximately 52%, or more than half its capital.
Hedge funds generally charge 2% of assets a year in management fees. They also take 20% of all gains as a performance fee.
The performance fee is the real prize. But there’s a catch: the fee is governed by something called a “high-water mark.”
This means you can’t lose money, then charge investors a performance fee as you make it back.
High-water marks exist for a very good reason. Without them, a fund could be incentivized to repeatedly lose money then earn it back, collecting fat fees every time while investors make nothing.
To attempt to remove the high water mark, and charge people a fortune to make back the billions you lost, is the height of hubris.
Plotkin’s investors seem to be as affronted by his proposal as I am. So where does that leave Melvin Capital?
Since investors won’t let them remove the high-water mark, it could be years before Melvin can charge performance fees again, if ever. Their better traders are likely to leave for greener pastures.
Meanwhile, the fund is also caught up in a federal investigation of improper activity by short sellers.
With angry investors, no juicy fees in sight, and a federal investigation looming, I expect Melvin to shut down soon. This would leave Plotkin free to create a new fund and start earning fees again while distancing himself from the Melvin dumpster fire.
For those who will be tempted to invest with Plotkin again, remember these wise words:
What do you think is next for Melvin Capital and Gabe Plotkin? Leave a comment at the bottom and let me know!
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