Turn to Your Left at the End of the Sky

Why Investment Bankers are Wealthy

A large amount of the money flowing into private equity and venture capital comes from pension funds. Typical venture funds charge 2.5% fees annually. The pension fund managers also charge a fee (around 0.3%) to manage the entire pension fund. Often, there is an additional layer of fees if the pension fund manager decides to access the venture capital asset class through a fund-of-funds. Fund-of-fund managers typically charge 1% for their services (picking the underlying venture funds). The total fees that an 85-year old nurse is being charged on her pension is therefore close to 4%. And this does not even take into account the 20% of any profits which are allocated to the VC’s, the 5% of profits added to the fund-of-funds manager and the bonus allocated to the pension fund manager.

All this leads me to my broader point: why are people content to give up almost 5% of their life savings annually. The long term returns on stock investing is 8-9% depending on the time frame and those returns are easily accessible to anyone through low cost (<0.2%) exchange-traded index funds. It is unlikely that venture funds will return in excess of 15% annualized IRR over the next few decades. And even if they do, all the compensation for taking on the additional risk goes to the finance industry.

There is a similar phenomenon in the public markets. Mutual fund fees are often as high as 2%. Why are people willing to pay those fees when there is an abundance of evidence that the vast majority of fund managers underperform the indices they are attempting to track?


August 25, 2006 - Posted by | Investing


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