Monday, June 22, 2009

The ROI of Lobbying

The Journal has a story today about the increase in hedge fund lobbying over the last few years. Here's one example:

One of the biggest hedge-fund lobbyists is Citadel Investment Group, which spent a total of $1.9 million from 2007 through the first quarter of this year, records show.

Citadel has somewhere around $15 billion in assets under management, give or take whatever the market is up to when you read this. That means they probably collect around $300 million in management fees (2%of AUM). Let's say further that they have a slow year and make a 10% return, or add $1.5 billion in value to the company. Under the typical 2-and-20 arrangement they would take home another $300 million in carry (20%) from the fund's profits. So under very unheroic assumptions these guys stand to make $600 million a year.

Now let's say that whatever lobbying they can do adds 1 basis point to their returns -- so that they make 10.01% or 1.0101 times their money. This would add $1.5 million to the fund's profits for the year, of which they would take home $0.3 million as their direct share. All things being equal, this would also increase the fund's AUM by $1.5 million at the end of the year, which translates into $0.03 million more in management fees for the next year. Adding one basis point to their returns in just one year translates directly into $330,000 in these guys pockets. This doesn't quite pay for an $850,000 annual lobbying campaign, but it puts you in the neighborhood of break even.

You can put whatever number you want in for the incremental return of lobbying. If you think they can add 10 basis points or 0.1% to the returns with some clever legal maneuvering, then they will add $15 million to the funds profits, and personally pocket an incremental $3.3 million. The return on lobbying would be somewhere in the neighborhood of 380%. Not too shabby as an investment. They break even if they can increase returns by 2.6 basis points. And none of this includes the fact that being seen as plugged in to the Washington establishment obviously helps you raise more money and expand the fund.

I know I'm belaboring the obvious here, but I've always wanted to do that math. The return you get from investing in lobbying can be huge. In addition, it scales well as a business model because you don't necessarily need to spend more as the size of your fund increases, and given the fact that human politicians are a bottleneck with limited amounts of time, but large influence over an entire industry, lobbying also allows you to build a competitive advantage. It's a classic network effect type business model where an initial investment puts you ahead and builds a sustainable moat around your business.

Corruption is a natural and inevitable consequence of large concentrations of capital vying to produce the best returns under conditions of centralized government.

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