Investors pay millions to watch two billionaires fight over a stock

Two hedge fund giants, Bill Ackman and Carl Icahn, are currently having a very public fight over the future prospects of Herbalife (HLF), a publicly traded company. Ackman runs Pershing Square Capital Management, and Icahn’s fund is Icahn Partners.  Much of the financial world stopped last Friday to watch these two billionaires take pot shots at each other on CBNC.  The whole thing is below (WARNING: there is quite of a bit of profanity involved).

Basically, Ackman made some very public accusations about the viability of Herbalife’s business model and hinted that he had a very significant ($1 billion) short position – he is betting heavily against the stock with his investor’s money.  Two other hedge fund managers, one of whom being Carl Icahn, rushed to HLF’s defense and announced that they have “long” positions – they are betting on the stock with their investor’s money.

So, here we are with these billionaires arguing on national television about whether a stock is going to do up or go down.  One side of this argument will eventually be right.  I don’t particularly care (although it is entertaining in a “The Real World” meets Gordon Gecko meets “Real Housewives” kind of way).   While the story has been focused on the televised cage match between these two hedge fund managers, the untold story is what is going to happen to their investors.

A typical hedge fund manager charges a 2% annual management fee and takes 20% of any and all profits from the fund.  Here we have two fund managers taking their 2% and fighting over one stock.  One will be wrong and have no gain to take his 20% from, and the other will profit nicely by skimming his 20% off the top of the return.  On a net-net basis, it’s the investors that are going to lose their shirts.  The investors will pay 2% to these two egomaniacs and the “winning” team will part with more of their cash for the 20% rake.  All in, it is reasonable that investors in these two funds will pay 3-4% or more this year for this public fight.  On a net basis, they will underperform because the managers are going to take a chunk of the gain and their 2% management fee, right or wrong. In fact, hedge fund managers have underperformed the simplest of portfolios for years.

The thing is, you don’t have to be an investor in Ackman’s fund or Icahn’s fund or any hedge fund to part with your money in this way.  The same thing happens every day in the world of actively managed mutual funds and separate accounts.  One manager likes a stock, and one doesn’t.  You may very well own both. In the end, you pay the managers 1%+ and end up with roughly the market exposure to the stock.  You pay the management fees (1%) and the funds’ costs of trading the stock (1%+) and the IRS (1%) your net return is the market return, less all of these costs, and you get to keep what is left over.

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