This $3.8 billion hedge fund is shaking up the industry with its

(Click here to subscribe to the Delivering Alpha newsletter.)

When Peter Kraus founded Aperture Investors, he deviated from the traditional active management model. Rather than raking in fixed fees, Kraus’ $3.8 billion firm operates on a fee structure linked to performance, charging 30 percent of alpha. That’s higher than the industry standard but since inception, about half of Aperture’s funds have delivered alpha above their benchmarks. Kraus sat down with CNBC’s Delivering Alpha newsletter to explain why he’s focused on a pay-for-performance set-up and how he’s putting capital to work in the current environment. 

(The below has been edited for length and clarity. See above for full video.)

Leslie Picker: What do you see as the key problem with the traditional model? And what do you think is the best way to fix it?

Peter Kraus: The key problem is very simple. The existing model in almost all cases, rewards people whether or not they perform. So, it’s a fixed fee and as assets grow, you earn more money. Well, clients don’t actually hire us to grow our assets, they hire us to perform. So, you would think the performance fee or the actual fee would be connected to the performance as opposed to the asset growth. We also know that asset growth is the enemy of performance. It’s harder and harder to perform, the more assets that you manage. So, the fee doesn’t help you – that traditional fee doesn’t help in that regard, because the manager is incentivized to continue to grow assets, and that makes it harder and harder to perform. 

Of course, there are performance fees in the marketplace and hedge funds and private equity, but they also have rather large management fees. So, they too have some incentive to grow their assets. Basically Aperture is the anathema to that – it’s the opposite. We charge a very low base fee that’s equal to the ETF and then we only charge if we beat the index. So, you pay for performance. If we don’t have any performance, you pay what you pay to buy the ETF. 

Picker: So, then how do you choose which index is relevant for the specific strategies?. I mean, do you invest in certain ways that would mirror or would be comparable to certain indexes that you’re able to then outperform?

Kraus: Exactly. So, we’re very, very thoughtful about the index because we’re actually charging people to beat the index. So, for example, in global equities, we would use the MSCI global equity index. For U.S. small cap, we would use the Russell 2000. For European equities, we would use the Euro Stoxx Index. Very simple indices, not complex, no real question about whether the manager is actually creating a portfolio that is following that index. In fact, we actually test the correlation of the portfolio to the index to make sure the index continues to be relevant.

Picker: People who advocate for their management fee will say that it’s necessary, essentially, to keep the lights on – that it basically ensures that the operations of the fund can…