Archive for August 25th, 2006

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?