Lars Kroijer got rich charging investors fat fees as a manager of his hedge fund, Holte Capital.
Now Mr. Kroijer, 38 years old and the author of a book, “Money Mavericks, Confessions of a Hedge Fund Manager,” has had something of an epiphany about the fees that these lightly regulated investment pools charge.
He now thinks that the fees are too high in many cases and that investors would be better off putting their money in a Vanguard index mutual fund.
Hedge funds typically charge an annual management fee of 2 percent and a performance fee of 20 percent, meaning investors keep 80 percent of the gain. Fund managers justify the fee structure by saying that they do well only when you do. Mr. Kroijer, who started his fund with $3.5 million and increased its assets to about $300 million, charged a management fee of 1.25 percent and a performance fee of 20 percent.
Speaking in London last week to lawyers and prospective hedge fund managers, Mr. Kroijer said he had his awakening in early 2006 while at the wedding of a friend outside Chicago.
As he tells it, he was talking to the bride's aunt who asked what he did for a living. When he responded that he worked at a hedge fund, she, sounding somewhat offended, replied: "I know what a hedge fund is."
It turned out her husband, who was a couple of years away from retiring from his job at a supplier to a Detroit automaker, was investing in hedge funds through his pension plan. Hedge funds, the woman told Mr. Kroijer, were like a "a guarantee against markets going down." She didn't know which hedge funds her husband's pension money was invested in, but she said the plan used a fund of funds to pick the investments.
That got Mr. Kroijer thinking about how many mouths there are to feed before an investor in a hedge fund actually sees a return. Like any good business school graduate, (Mr. Kroijer went to Harvard as an undergraduate and got his M.B.A. from there), he decided to do the numbers. His conclusion: Even if a hedge fund had a return of 10 percent before trading expenses, an investor would wind up with a little less than 3 percent. That's because there are so many fees to pay. Among them are fees for fund of funds and pension managers, not to mention, of course, the expense of the hedge funds.
If the hedge fund had gotten its 10 percent return by simply going "long" or being bullish the market in a year when the market was up 10 percent, than an average investor would have been better off buying a Vanguard index fund and paying 0.2 percent in total fees rather than the 7 percent.
"That is a huge problem for the industry," he said Friday during a breakfast briefing at the Kaye Scholer law firm.
Hedge funds had something of an "emperor has no clothes" moment in 2008 when hundreds of hedge funds were found to have simply gone long the market and generated little value to justify their lofty fees.
Unlike a lot of hedge fund managers who ascribe their wealth to their own wizardry, Mr. Kroijer is self-deprecatingly funny about his journey to riches. He arrived in United States 20 years ago from Denmark to study for his year abroad at the University of Massachusetts, Amherst. After a professor suggested he apply to Harvard during his first year, he retook his verbal SAT, on which he had scored 280 the first time. He got into Harvard, though, he admits he probably had the lowest combined SAT score at the university. (He managed to double his verbal SAT score the second time around.)
During the firm's first week, when it had only $3.5 million, Mr. Kroijer recalls having to call Morgan Stanley to borrow one share to put on a short position, or bearish bet. The broker "wanted to get off the phone so quickly so she could tell the whole desk about how someone wanted to borrow one share," he said.
Mr. Kroijer wound down Holte in early 2008 after performing poorly in 2007.
"People ask: "?Did we blow up,'" Mr. Kroijer told the group. "No"¦but it is also a lie to say people were begging us to continue."
But do not worry about Mr. Kroijer.
He's dreaming up the next hot investment "” a low-cost product that uses optimal portfolio theory to allocate money between cheaply bought indices so as to minimize the correlation of the countries investors are exposed to in an effort to reduce their risk.
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