Why can't you just have someone invest for you and split the profits (and losses) with him?

Question

There is a large sector of professionals providing the basic service of "take your money and invest it for you". However, it appears that none of these people want to share the profit nor the risk, but instead aim to derive money from the investor's foolishness.

• Some take flat fees to make use of their services. They make money whether or not I lose money, so the only reason for them to do well is to attract/retain customers. But customers can be retained in other ways, so there is actually nothing making them invest my money sensibly.
• Some take a fee per trade. This is even worse, since now the fund/manager is incentivized to make many useless trades, that make me no income, but earn them lots of commissions.

Why is nobody providing a service that is basically:

Give me your money. I will invest it as I see fit. A year later I will return the capital to you, plus half of any profits or losses. This means that if your capital under my management ends up turning a profit, I will keep half of those profits, but if I lose you money, I will cover half those losses.

In this way, there is no doubt that the manager is incentivized to do a good job, and bad managers are disincentivized from seeking customers since they will be wary of losing money. In effect, the transaction is like selling a trader a leveraged ETF of himself. Anyone who believes they are more likely to make money than not has little reason to refuse such a deal.

However, I have never seen a mutual fund, ETF, or other reputable instrument producing this effect. Do they simply not exist? Why not?

Note: The details of this arrangement are of course immaterial. It can be 20%, 80%, or whatever other fraction of proceeds, and it can be a year, or more, or less. The key point is that the manager must share profits and losses.

Answer 1

The 2 and 20 rule is a premium arrangement that hedge funds offer and venture capital funds offer, and they also offer different variations of it. The 2 is the management fee as percent of assets under management, the 20 is the profit cut, which they only get if they are profitable.

There are 0/20, 1/15, and many variations. You're assuming that nobody offers this arrangement because it isn't offered to you, but that's because nobody offers it to people that aren't wealthy enough to legally qualify for their fund.

When you park 6 or 7 figure amounts in bank accounts, they'll send your information out to the funds that operate the way you wish they operated.

Answer 2

This means that if your capital under my management ends up turning a profit, I will keep half of those profits, but if I lose you money, I will cover half those losses.

The bold part is where you lose me.

This absolutely exists with the exception of the loss insurance. It just requires a lot more than the general retail consumer investor has to contribute. Nobody wants to take on the responsibility of your money then split 50% of the gross proceeds of your $10,000 (or whatever nominal amount of money you're dealing with) investment and return it all to you after a year. And NO money manager will insure that the market won't decline.

Hedge funds, PE Firms, VC Firms, Investment Partnerships, etc all basically run the way you're describing (again without your loss insurance). Everyone's money is pooled and investments are made. Everyone shares the spoils and everyone shares the losses. And to top it off, the people making investment decisions have their money invested in the fund. All of them have to pay rent and accountants and other costs associated with running the fund and that will eat in to the proceeds to some degree; because returns are calculated on net proceeds.

With enough money you can buy yourself in to a hedge fund, for the rest of us there are ETFs and other extremely fee-reasonable investment options. And if you don't think the performance and preservation of assets under management is not an incentive to treat the money with care you're kidding yourself (your first bullet point).

I'll add that aside from skewing the manager's risk tolerance toward guaranteed returns I doubt you would fair favorably over the long term compared to simply paying even an egregious 1% expense ratio on an ETF. If you look at the S&P performance for 10 or 20 or however many years, I'd venture that a couple good years of giving up half of your gains would have you screaming for your money back. The bad years would put the money manager out of business and the good years would squander your gains.

Answer 3

You are conflating two different types of risk here.

First, you want to invest money, and presumably you're not looking at the "lowest risk, lowest returns" end of the spectrum. This is an inherently risky activity.

Second, you are in a principal-agent relationship with your advisor, and are exposed to the risk of your advisor not maximizing your profits. A lot has been written on principal-agent theory, and while incentive schemes exist, there is no optimal solution.

In your case, you hope that your agent will start maximizing your profits if they are 100% correlated with his profits. While this idea is true (at least according to standard economic theory, you could find exceptions in behavioral economics and in reality), it also forces the agent to participate in the first risk.

From the point of view of the agent, this does not make sense. He is looking to render services and receive income for it. An agent with integrity is certainly prepared to carry the risk of his own incompetence, just like Apple is prepared to replace your iPhone should it not start one day. But the agent is not prepared to carry additional risks such as the market risk, and should not be compelled to do so. It is your risk, a risk you personally take by deciding to play the investment gamble, and you cannot transfer it to somebody else.

Of course, what makes the situation here more difficult than the iPhone example is that market-driven losses cannot be easily distinguished from incompetent-agent losses. So, there is no setup in which you carry the market risk only and your agent carries the incompetence risk only. But as much as you want a solution in which the agent carries all risk, you probably won't find an agent willing to sign such a contract. So you have to simply accept that both the market risk and the incompetence risk are inherent to being an investor.

You can try to mitigate your own incompetence by having an advisor invest for you, but then you have to accept the risk of his incompetence. There is no way to depress the total incompetence risk to zero.

Answer 4

Why is nobody providing a service that is basically:

Give me your money. I will invest it as I see fit. A year later I will return the capital to you, plus half of any profits or losses. This means that if your capital under my management ends up turning a profit, I will keep half of those profits, but if I lose you money, I will cover half those losses.

Because they can already make lots of money by just charging people an unconditional fee and not having to cover their losses. Why take on the risk of having to cover your losses when they can just take a percentage of your assets and stick you with any losses?

In addition, as Charles E. Grant mentioned in a comment on another answer, if a person has both sufficient capital to cover your losses and sufficient confidence in their investing acumen that they don't think they will have to do so, they have little need for your money. Rather than take half the gains on your money, they will invest their own money (they must have some, or else they can't guarantee your losses) and take all the gains.

Your scheme would only be plausible as a partnership between a person with investing skills but little capital, and another person with ample capital and less skill. In that case, the investment whiz could genuinely benefit from access to the bankroller's capital. As quid noted in chat, this does exist in the form of ad-hoc private equity arrangements between individuals. However, such a setup is unlikely to exist as an "off-the-shelf product" marketed at retail investors, because financial institutions have more capital than any individual retail investor -- and, more generally, anyone with sufficient skill to pull this off will (at least in theory) quickly accumulate enough capital that they can negotiate a less risky payment plan.

Answer 5

The issue is the time frame. With a one year investment horizon the only way for a fund manager to be confident that they are not going to lose their shirt is to invest your money in ultra conservative low volatility investments. Otherwise a year like 2008 in the US stock market would break them.

Note if you are willing to expand your payback time period to multiple years then you are essentially looking at an annuity and it's market loss rider. Of course those contacts are always structured such that the insurance company is extremely confident that they will be able to make more in the market than they are promising to pay back (multiple decade time horizons).

Answer 6

For one thing fund managers, even fund management companies, own less money than their clients put together. On the whole they simply cannot underwrite 50% of the potential losses of the funds they manage, and an offer to do so would be completely unsecured. Warren Buffet owns about 1/3 of Berkshire Hathaway, so I suppose maybe he could do it if he wanted to, and I won't guess why he prefers his own business model (investing in the fund he manages, or used to manage) over the one you propose for him (keeping his money in something so secure he could use it to cover arbitrary losses on B-H). Buffett and his investors have always felt that he has sufficient incentive to see B-H do well, and it's not clear that your scheme would provide him any useful further incentive.

You say that the details are immaterial. Supposing instead of 50% it was 0.0001%, one part in a million. Then it would be completely plausible for a fund manager to offer this: "invest 50 million, lose it all, and I'll buy dinner to apologise". But would you be as attracted to it as you would be to 50%? Then the details are material.

Actually a fund manager could do it by taking your money, putting 50% into the fund and 50% into a cash account. If you make money on the fund, you only make half as much as if you'd been fully invested, so half your profit has been "taken" when you get back the fund value + cash. If you lose money on the fund, pay you back 50% of your losses using the cash. Worst case scenario[*], the fund is completely wiped out but you still get back 50% of your initial investment. The combined fund+cash investment vehicle has covered exactly half your losses and it subtracts exactly half your profit. The manager has offered the terms you asked for (-50% leverage) but still doesn't have skin the game. Your proposed terms do not provide the incentive you expect.

Why don't fund managers offer this? Because with a few exceptions 50% is an absurd amount for an investment fund to keep in cash, and nobody would buy it. If you want to use cash for that level of inverse leverage you call the bank, open an account, and keep the interest for yourself. You don't expect your managed fund to do it.

Furthermore, supposing the manager did invest 100% of your subscription in the fund and cover the risk with their own capital, that means the only place they actually make any profit is the return on a risk that they take with their capital on the fund's wins/losses. You've given them no incentive to invest your money as well as their own: they might as well just put their capital in the fund and let you keep your money. They're better off without you since there's less paperwork, and they can invest whatever they like instead of carefully matching whatever money you send them. If you think they can make better picks than you, and you want them to do so on your behalf, then you need to pay them for the privilege. Riding their coattails for free is not a service they have any reason to offer you.

It turns out that you cannot force someone to expose themselves to a particular risk other than by agreeing that they will expose themselves to that risk and then closely monitoring their investment portfolio. Otherwise they can find ways to insure/hedge the risk they're required to take on. If it's on their books but cancelled by something else then they aren't really exposed. So to provide incentive what we normally want is what Buffett does, which is for the fund manager to be invested in the fund to keep them keen, and to draw a salary in return for letting you in[**]. Their investment cannot precisely match yours because the fund manager's capital doesn't precisely match your capital. It doesn't cover your losses because it's in the same fund, so if your money vanishes the fund manager loses too and has nothing to cover you with. But it does provide the incentive.

[*] All right, I admit it, worst case scenario there's a total banking collapse, end of civilization as we know it, and the cash account defaults. But then even in your proposed scheme it's possible that whatever assets the fund manager was using as security could fail to materialise.

[**] So why, you might ask, do individual fund managers get bonuses in return for meeting fixed targets instead of only being part-paid in shares in their own fund whose value they can then maximise? I honestly don't know, but I suspect "lots of reasons". Probably the psychology of rewarding them for performance in a way that compares with other executive posts or professions they might take up instead of fund management. Probably the benefit to the fund itself, which wants to attract more clients, of beating certain benchmarks. Probably other things including, frankly, human error in setting their compensation packages.

Answer 7

On reflection there are financial products that do what you want, whole-life insurance policies that guarantee an annual dividend calculation on some index with a ceiling and floor. So you will have a return within a defined minimum and maximum range.

There are a lot of opinions on the internet on this. This Consumer Reports article is balanced

These have a reputation for being bad for the consumer compared to buying term life and investing in a mutual fund separately, but if you want the guarantee (or are a "moral hazard" for a life insurance policy, closer to death than you appear on paper) it may be a product for you.

If you're very wealthy, there is an estate tax exploit in insurance death benefits that can make this an exceptional shield on assets for your heirs, with the market return just the gravy.

Answer 8

What you are looking for is a pretty terrible deal for you, so I'd say it doesn't exist because there isn't a market for it, or nobody has noticed there is a market for it.

In principle I would happily take the deal you offer from as many people as would let me, put the money into treasury bills, and take half the profits while doing pretty much nothing.

If I had more risk tolerance I would be pretty happy to have half the value of my "fund" as zero cost investment capital for more aggressive investments. My business would then be a lot like an insurance company without the hassle of selling insurance to get hold of float to invest. Also, most insurance companies actually lose money on policies, but come out ahead by investing the float, so an insurance company with zero cost float is quite a good business.

Another answer mentions Berkshire Hathaway. If you read one of the famous Berkshire Hathaway annual letters to shareholders and read the section about insurance you'll see that very low cost float has a large role in that company's success.

So, back to your end of the deal: if the deal is that good for me, how good is it for you? I'd have to double market returns just for you to break even. If you're smart enough to pick a financial adviser that can beat the market by that much, how come you aren't able to pick an investment strategy that ties the market?

Answer 9

Give me your money. I will invest it as I see fit. A year later I will return the capital to you, plus half of any profits or losses. This means that if your capital under my management ends up turning a profit, I will keep half of those profits, but if I lose you money, I will cover half those losses.

Think about incentives.

If you wanted an investment where your losses were only half as bad, but your gains were only half as good, then you could just invest half your assets in a risk-free investment. So if you want this hypothetical instrument because you want a different risk profile, you don't actually need anything new to get it.

And what does the fund manager get out of this arrangement? She doesn't get anything you don't: she just gets half your gains, most of which she needs to set aside to be able to pay half your losses. The discrepancy between the gains and losses she gets to keep, which is exactly equal to your gain or loss. She could just invest her own money to get the same thing.

But wait -- the fund manager didn't need to provide any capital. She got to play with your money (for free!) and keep half the profits. Not a bad deal, for her, perhaps...

Here's the problem: No one cares about your thousands of dollars. The costs of dealing with you: accounting for your share, talking to you on the phone, legal expenses when you get angry, the paperwork when you need to make a withdrawal for some dental work, mailing statements and so on will exceed the returns that could be earned with your thousands of dollars. And then the SEC would probably get involved with all kinds of regulations so you, with your humble means and limited experience, isn't constantly getting screwed over by the big fund. Complying with the SEC is going to cost the fund manager something. The fund manager would have to charge a small "administrative fee" to make it worthwhile. And that's called a mutual fund.

But if you have millions of free capital willing to give out, people take notice. Is there an instrument where a bunch of people give a manager capital for free, and then the investors and the manager share in the gains and losses?

Yes, hedge funds! And this is why only the rich and powerful can participate in them: only they have enough capital to make this arrangement beneficial for the fund manager.

Answer 10

At this point the cost of borrowing money is very low. For the sake of argument, say it is 1% per year for a large institution.

I can either go out and find a client to invest 100,000$ and split profit and loss with them.

Or, I could borrow 50,000$, pay 500$/year in interest, and get the same return and loss, while moving the market half as much (which would let me double my position!)

In both cases the company is responsible for covering all fixed costs, like paying for traders, trades, office space, branding, management, regulatory compliance, etc.

For your system to work, the cost to gather clients and interact with them has to be significantly less than 1% of the capital they provide you per year.

At the 50% level, that might actually be worth it for the company in question. Except at the 50% level you'd have really horrible returns even when the market went up. So suppose a more reasonable level is the client keeps 75% of the returns (which compares to existing companies which offer larger investors an 80% cut on profits, but no coverage on losses).

Now the cost to gather and interact with clients has to be lower than 2500$ per million dollars provided to beat out a simple loan arrangement. A single sales employee with 100% overhead (office, all marketing, support, benefits) earning 40,000$/year has to bring in 32 million dollar-years worth of investment every year to break even.

Cash is cheap. Investment houses sell cash management, and charge for it. They don't sell shared investment risk (at least not to retail investors), because it would take a lot of cash for it to be worth their bother.

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More explicitly, for this to be viable, they'd basically have to constantly arrange large hedges against the market going down to cover any losses. That is the kind of thing that some margin loans may require. That would all by itself lower their profits significantly, and they would be exposed to counter-party risk on top of that.

It is much harder to come up with a pile of cash when the markets go down significantly. If you are large enough to be worthwhile, finding a safe counterparty may be nearly impossible.

Answer 11

because the market price for good investment advice isn't that low. investment advice is subject to market pricing just like any other good or service. if you are good enough at investing that you seek increased volatility opportunities, you will have no trouble finding investors willing to give you a share of the upside without any of the downside risk.

Answer 12

I'm answering this from a slightly different angle, but there are people (individuals) who will do this for you. I know private Forex traders who are 'employed' to manage Forex trading accounts for wealthy individuals. The trader takes a percentage of the wins but is also responsible for a percentage of the loss (if there is a loss in a particular month). However the fact that the trader is able to prove that they have a consistent enough trading history to be trusted with the large accounts generally means that losses are rare (one would hope!).

Obviously they have contracts in place (and the terms of the contract are crucial to the responsibility of losses) etc. but I don't know what the legalities are of offering or using this kind of service. I just wanted to mention it, while perhaps not being the best option for you personally, it does exist and matches your requirements.

You would just have to be extremely careful to choose someone respectable and responsible, as it would be much easier to get ripped off while looking for a respected individual to trade your account than it would be while looking for a respected firm (I would imagine).

Answer 13

Written with some mild snark , but no insult intended, because financial stuff can be ridiculously confusing...

Looked at another way, you're basically asking if the Biblical "Parable of the Talents" can be implemented as a business model.

You as the investor wish to be the "master", with the entity doing the investing playing the part of the "servant". Since the law prohibits actual servitude as described in scripture, the model must substitute a contractual profit- and loss-sharing scheme.

OK, based on what you've proposed, and by way of example, let's say you invested a thousand dollars. You give the investment service your money. At the end of a year, they give you back - Your capital ($1000) - Plus 1/2 of any profits OR - Less 1/2 of any losses

So let's say the worst happens and they lose ALL of it. According to your proposal, they have to cover 1/2 of the loss.

You end up with $500...but they end up with LESS than nothing. They will be in a deficit situation because all the expense was theirs. They don't just fail to make a profit. They go in the hole.

It doesn't matter what percentages you use. Regardless of how the loss is shared, you've only guaranteed YOU can't lose all your money. The company CAN. Given a large enough investment, or enough market fluctuation, a big shared loss could shut down a smaller firm.

To summarize: - You want a service that charges you nothing - Does all the work of expertly managing and investing your capital - Takes on part of the risk you would normally bear - (on top of their usual risk and liability) - Agrees to do so solely for a percentage of any return (where higher returns will likely involve a higher degree of risk) - AND that guarantees, after just 1 year, you'll get X% of your capital back, no matter what. Win or lose. - Even if the market crashes and all your capital, and theirs, is wiped out

Superbest, um, to be serious briefly: what you're proposing is, if nothing else, inherently unfair and inequitable. I believe you intended it as a mutually beneficial scenario, but the real-world imbalance in risk and reward prevents it being so. Any financial service that would accept those terms along with the extra degree of risk would be fiscally irresponsible. From a business standpoint it's an untenable model, and no company would build on it. It would be tantamount to corporate suicide.

The requirement that a service promise to give you back X% of your money, no matter how great the loss, makes your proposal impossible. You need to think about how much all this costs, realistically, as well what kind of returns you can actually expect. And that more risk for higher return is exactly what a service could NOT take a chance on if it had to "share" investors' losses.

Besides, it's not really sharing, now is it? They will always lose more than you, always end up in a negative situation, unable even to recoup costs. Circumstances beyond their control could result in a drop in the value that not only wipes out any profit, but requires them to pay YOU for work performed and expenses incurred on your behalf.

Why would they let anyon double-dip like that? Yeah, we all prefer getting something for nothing...but you want valuable services and for them to pay you money for the privilege of providing them? I totally agree that would be fantastic, but in this world even "free" doesn't come cheap anymore.

And getting back to costs: Without consistent income the service would have nowhere to work and no resources to work with. No office, computer, phone, electricity, Internet, insurance, payroll, licensing, training, maintenance, security, lobbying, etc., etc., etc. Why do people always forget overhead?

There's a reason these services operate the way they do. Even the best are working with fairly slim margins in a volatile sector. They're not into 1-year gambles unlikely to cover their cost of doing business, or having to pay for a negative return out of their own pocket.

Look, if you're the Biblical master asking your servant to manage things, overhead is built-in. You're taking all the risk as well. You're paying for all three servants' food, home, clothing, etc, plus you had to buy the servants themselves. So its reasonable that you reap the reward of their labor. You paid for it, and you didn't even punish the servant who buried your money in a hole. The two good servants may have done the legwork, but you took on the burden of everything else.

In your proposed service, however, contrary to the servant's usual role, the servant - i.e., the company - would be assuming a portion of your risk on top of their own, yet without any guarantee of profit, income, or even coverage of costs. They're also subject to regulations, fees, liability, legal stuff, etc. that you're not, against most of which you are indemnified and held harmless. If they agree to cover a share of your loss, it exposes to greater liability and more related risk. It robs them of resources they need to invest in their own business, while at the same time forcing them to do all the work.

As a result, your model doesn't give such a service a fighting chance. Getting it off the ground and lasting past the first-year payouts would require more luck than skill.

They'd be better off heading to Vegas and the blackjack table, where the only overhead is a cheap flight and room, where the odds and rules don't change overnight, and they at least get free drinks.

If none of the equivalents satisfies, then the Biblical parable appears to describe your only option for obtaining exactly what you want: Move to a country where slavery is legal and buy an investor :-)

Cheers, c

Answer 14

A 'indexed guaranteed income certificate' (Market Growth GIC) fits the criteria defined in the OP.

The "guaranteed" part of the name means that, if the market falls, your capital is guaranteed (they cover the loss and return all your capital to you); and the "index linked" or "market growth" means that instead of the ROI being fixed/determined when you buy the GIC, the ROI depends on (is linked to) the market growth, e.g. an index (so you get a fraction of profit, which you share with the fund manager).

The upside is that you can't 'lose' (lose capital). The fund manager doesn't just share the losses with you, they take/cover all the losses.

The downside is that you only make a fraction of whatever profit you might make by investing directly in the market (e.g. in an index fund). Another caveat is that you buy a GIC over some fixed term, e.g. you have to give them you money for a year or more, two years.

Answer 15

Such an offer has negative value, so it's hard to see how it would make sense to accept it.

The offer has two components, one part that you gain and one part that you lose. The gain is that half your losses are covered. The cost is that half your profits are lost. For that to be a net benefit to you, you would have to expect that you will gain more from this than you will lose from it. That is, you must expect that the investment has negative value. But if you expect that the investment has negative value, why are you investing?

This also doesn't really align incentives between the two parties. The person choosing the investment is not incurring opportunity cost (because they have no funds locked up) while you are. So they have an incentive to be conservative that you do not.

For example, say I could make 1% in an ultra low risk CD. The person choosing the investments has an incentive to put me in something that he only expects to make around 0.5% (because he gets to keep half the profits and it costs him nothing). Whereas I'd rather just put the money in a CD (because I get to keep 1% instead just half of 0.5%).