Slaughtering the Sacred Cows of the trading industry

[ProfitTakgFool]

Another problem with point 3 is it also gives the manager the incentive to stop trading the fund if the drawdown is viewed as too high to overcome. If it would take 2 years, for example, to get back above a 30% loss where's the incentive to keep trading the Fund and receive no income during that 2 year period? The manager would be better off to start another fund, like you mentioned, or even trade his or her own account and keep 100% of the profits.

And, a 2%, 20% is not a bad deal if the 2% is based on profitability. Agree with the OP, no fund manager should get paid for losing investor's money. The 2% on profitability does, however, give the manager an incentive to deliver a nice return without over-exposure to risk. If the manager collects only the 20% then he has an incentive to juice up the position sizes. If a manager does 25% or 30% or even a sliding scale he/she also has an incentive to take on more risk. Giving the manager 2% based on profitability is a good deal because the manager doesn't feel the need to swing for the fences and reach a 100% return to collect an additional check. Theoretically, the managed capital will exceed profit capital so it gives the manager an incentive to work, but not the incentive to go too large.

Excellent post by the OP!

Quote from neke:

I have thought about (3) above, but the problem is the managers would shut-down and start another fund once they have a losing year, so as not to carry forward any loss. But point (2) seems to fix it in those situations when the manager has good years prior to the loss. Great thoughtful recommendations that should be adopted in a rational world. Unfortunately, we do not live in such a world (as yet), and the operators will always find a cheap way out.