Dear Cassie....

In a new feature, "Dear Cassie" will be a periodic column where readers pose their burning questions to an often-verbose but delphic seer with an excess of opinions over credibility.

Today's letter features a question by a reader regarding HF manager's potentially confused moral sensibilities. She writes:



Dear Cassandra,

We generally think of Americans as the epitome of "Greed is Good" whereas one sees the Brits as somehow less singularly capitalist-minded. Intriguingly, I saw that Jeff Larson gave back investors the massive windfall of performance fees his firm, Sowood, earned in 2006 for managing hedge funds even though the losses themselves didn't force the funds into liquidation (unsightly and unwanted as they were). Recently, I read that Cheyne Capital earned megabucks in performance fees upon funds under management in 2006, and shortly thereafter a very large SIV they managed went POOOOF! into liquidation. I heard no mention of THEM returning Performance Fees earned in regard to their management of the SIV. What gives? Is Mr Larson a saint, or an ass?

Yours truly,

Ms. N. Censed
The Boltons-nr.Chelsky


Dear Ms Censed,

First, thank you for the observation. I've been mulling over this myself. I think it opens up an interesting topic for discussion. First, lets be clear that by the letter of the law (thank you Siddeley Austin & Esq), Mr Larson had no such legal obligation by the letter of the law. It would have been well within his right to to take his many millions and go to the slums of Tijuana with bags of his money and throw into the street to watch the ensuing riot for his private enjoyment (and those of his friends). But Mr Larson is obviously not like that.

In Cheyne's case, let's also be clear that Cheyne runs many funds and the celebrated gobs of money recently paid that hit the press were not all SIV-loot. And even the SIV-booty is not blood-diamond money! And of course they had to repay some for scamming Inland Revenue. That said, the question remains: why did Mr Larson make such an apparently magnanimous gesture - seemingly out of cultural character, and the iron-clad legal documentation of the fund and investment management agreement, and Mssrs F&L make a similar gesture, that would have taken the heat off all us for being heartless scallywags?

This takes us to the heart of the matter: while the letter of the law says "You can keep it", the spirit of the "two-and-twenty" incentive-fee phenomena says " the purpose is to align interests between agent managers and principal investors". Now HF managers are alledgedly some of the smartest (or luckiest) guys in the world, and every one of them, EVERYONE, knows 2&20% creates massive asymmetrical agent vs. principal dilemmas, for firm owners, for PMs, traders, and for FoF intermediaries. High-water marks attest to the fact the spirit is to align, not reward gluttony. Everyone knows that crystallized performance fees are not the same thing as "banked returns" for investors. The ways and means of gaming the structure are too numerous to recount, and quite often results in less-than-deserved payouts for which there is no redress and is, at the end of the day, theft, pilfering, and larceny by any other name.
The same people know that a true system of aligning interests would NOT instantly crystallize fees on mark-to-market, instead insuring fees remain "accrued", and released only of the course of years, thereby continuing to float or accrue up or down in subsequent years until paid. Three years is reasonable in my opinion.

So you see Mr Larson was not being magnanimous, or only insuring his children wouldn't be blackballed from Harvard, but was adhering to the spirit of his agreement with investors, in disregarding the letter of the law in favor of his investors (who were his business partners), did The Right Thing. As for Cheyne, while it's not blood-diamond money, some would suggest that there is a khamric taint to the dosh so earned.

One final thought: IF Cheyne didn't want to break ranks and set a bad precedent for expectations that investors might be rebated prior performance fees, whenever their funds subsequently lost money, but still felt a pang of guilt, they could very easily have said "We don't feel right in keeping this money, but don't want to encourage inverse moral hazard, and so will donate performance fees earned in relation to the now-combusted SIV, to former Greenpeace founder Paul Watson's "Sea Shepherd Conservation Society".

Yours truly,

Cassandra