“Round-Tripping” Stocks and the Absurdity of Hedge Fund Fees


Hedge fund efficiency charges, I imagine, are a rip-off for purchasers. Few phenomena illustrate this higher than “round-tripping” shares. These are shares that, over the course of a number of years, for no matter purpose, see monumental worth beneficial properties solely to fall again to about the place they began.

During the COVID-19 period, many corporations have skilled such round-trip trajectories. That is to not say they had been unhealthy investments or their shares had been overpriced: Stocks go up and down for causes that aren’t all the time tied to fundamentals. But the diploma to which hedge funds revenue from these spherical journeys on the expense of their buyers is astounding.

Consider the efficiency of the web used automobile retailer Carvana.

Carvana generated 87% annualized returns between 1 January 2018 and year-end 2021 (1112% cumulative returns), boosting its market cap from $2.8 billion to $40 billion throughout that span.

But 2022 has not been so type. After peaking at $41 billion in 2021, Carvana’s market cap fell to $3.6 billion, with its shares down 91% for the calendar yr as of 1 July. That means the inventory returned a cumulative 9.7% since 1 January 2018 and has basically “spherical tripped” .

Carvana’s 4.5-Year Round Trip

chart showing the price movement of hypothetical company a stock

So, what would this imply for hedge funds and their restricted companions (LPs)?

Near Carvana’s Q2 2021 peak, utilizing knowledge from WhaleKnowledge, we estimate that hedge funds owned about 21% of the corporate’s inventory. These embody such well-respected outfits as 683 Capital, Tiger Global, D1 Capital, Lone Pine, Whale Rock, Sands Capital, and plenty of others with glorious long-term observe data.

Let’s assume that over the 4.5 years in query, hedge funds owned on common 20% of the excellent shares of Carvana and charged a 20% annual efficiency charge over a 0% hurdle price. How a lot would hedge funds have generated from purchasers by proudly owning Carvana over the timeframe? According to our calculations, they’d have crystalized $1.2 billion in charges within the three years between 2018 and 2020.

Trust Study Tile

This is solely gorgeous. Between 1 January 2018 and 1 July 2022, Carvana’s market cap went from $2.8 billion to $3.6 billion. Yet hedge funds would have crystallized 150% of that market cap acquire in charges. This constitutes a pure wealth switch from the palms of allocators into these of hedge fund managers.

2018 2019 2020 2021 2022 Cum. Current
Carvana Share
Price Return
71.1% 181.4% 160.2% –3.2% –91.0% 9.7%
Carvana Market
Cap, as of
1 January (Billions)
$2.8 $5.4 $12.0 $45.0 $40.1 $3.6
Percentage Owned by
Hedge Funds
20% 20% 20% 20% 20%
Hedge Fund
Performance Fee
20% 20% 20% 20% 20%
Implied Hedge Fund
Performance Fees
$79 $392 $771 $0 $0 $1,242

Note: 2022 returns via 1 July. Share worth and market cap don’t add up completely as Carvana issued fairness most years.

To ensure, that is solely an estimate and will overstate the efficiency charges generated by this inventory. For instance, negative-returning shares held by hedge funds mitigate the efficiency charges from positive-returning shares like Carvana. Moreover, completely different hedge funds have numerous efficiency charge crystallization necessities, equivalent to high-water marks, hurdles, and many others. Nevertheless, ours isn’t an unreasonable approximation, and it truly understates the general impression given the sheer variety of shares which have round-tripped.

Oh Snap! Another Round-Tripper*

Chart of Snap Stock PerformanceNote: Snap efficiency as of twenty-two July 2022.

Indeed, Carvana’s efficiency is hardly an outlier. Over the final a number of years, shares of Facebook, Roku, Sea Limited, Shopify, Snapchat, and Zoom, amongst many others, have skilled related “spherical journeys.” The takeaway is solely that the annualized efficiency charges paid to hedge funds result in absurd outcomes that all the time come on the expense and to the detriment of LPs.

Snap again to actuality, ope there goes gravity pic.twitter.com/813RLGbgxs

— Bucco Capital (@buccocapital) July 21, 2022

Why Wouldn’t Hedge Funds Do It This Way?

Hedge fund managers are incentivized to behave in their very own self-interest and maximize their very own wealth. They can be behaving rationally in the event that they signed up for $1.2 billion in efficiency charges in trade for delivering –5.6% in annualized web returns to purchasers. It’s a supremely enticing income stream for them, albeit an awfully poor one for his or her LPs.

2018 2019 2020 2021 2022 Cum. Ann.
Share Price Return
71.1% 181.4% 160.2% –3.2% –91.0% 9.7% 2.0%
Carvana as a
Hedge Fund Net Return
56.9% 145.1% 128.2% –3.2% –91.0% –23.2% –5.6%
S&P 500 TR –4.4% 31.5% 18.4% 28.7% –19.8% 53.6% 9.8%
Carvana Hedge Fund
Excess Return
61.2% 113.6% 109.8% –31.9% –71.1% –76.8% –15.4%

Note: 2022 returns via 1 July. Carvana hedge fund web returns assume a 20% efficiency charge over a 0% hurdle price and that Carvana is the one hedge fund funding.

While excessive, our instance demonstrates how efficiency charges can create perverse incentives for hedge fund managers. Far from higher aligning their pursuits, allocators that insist on paying for efficiency could also be making a foul state of affairs worse.

With shares like Carvana, hedge funds acquired a round-trip ticket during the last 4.5 years, with all bills paid — by their LPs.

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All posts are the opinion of the creator. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially mirror the views of CFA Institute or the creator’s employer.

Image credit score: ©Getty Images/BogdanV

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Jonathan Cornish, CFA

Jonathan Cornish, CFA, is the founder and portfolio supervisor of 38x Holdings, a long-biased funding agency based mostly in Miami, Florida. 38x Holdings invests in high-quality, publicly traded corporations with monopolistic traits. Prior to founding 38x Holdings, Cornish labored for UNC Management Company, a $10-billion endowment fund, in North Carolina. He graduated in 2016 from the McIntire School of Commerce on the University of Virginia, the place he performed on the lads’s tennis staff that gained three NCAA staff tennis championships throughout his 4 years. Cornish is from the UK and is a CFA charterholder. He could be reached at [email protected]


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