It seems that investors have been pressuring funds to change the "2 and 20" model for a bit now and smaller funds are cutting fees to attract investment.
Pressure from disappointed investors is forcing hedge funds to roll back their fees, putting the standard charge of 2% of assets under management and 20% of investment profits on the endangered list.Until a few years ago, most funds were like upscale New York restaurants: Some succeeded, others failed, but almost none cut prices. This pricing power was a product of the tens of billions of dollars that flowed into the industry after the tech meltdown of 2000, when savvy investments by some hedge funds shielded their investors from the drubbing suffered by holders of broad stock funds.
Impressive subsequent performance made hedge funds even less likely to trim the so-called 2 and 20 fees that made many money managers wealthy.But since the financial crisis, the failure of many hedge funds to produce returns perceived to be commensurate with their high costs has given rise to more assertive customers—notably pension funds and other institutions with billions to invest.
Today, the average hedge fund charges an annual management fee of about 1.6% of assets, while claiming around 18% of investment gains, according to industry surveys and interviews with industry executives. Investors willing to lock their money up for several years, write a big check or bet on a new fund can get even lower fees and other concessions, investors say.
Because hedge funds manage $2.41 trillion, according to industry-tracker HFR, a change of a few percentage points adds up to a lot of dollars. Last year, hedge funds pocketed $50.5 billion in management fees and performance fees, meaning the share of profits, HFR says.
The pressure to cut fees is felt most acutely by managers focusing on stocks and commodities, rather than bonds, because equity and commodity funds generally haven't posted outsize returns recently. Some debt strategies are more complex and expensive to implement, which tends to keep those fees higher.
New funds that trade stocks generally charge management fees of 1.5%, while funds that can have higher overhead still charge fees closer to 2%, said Steven Nadel, an attorney at Seward & Kissel LLP, which does an annual study of new funds.
Another reason fees are coming down: Investors increasingly choose to place money with large hedge funds, making midsize and smaller funds more eager to trim fees to attract money.
While a 2-and-20 setup was long seen as the industry standard, there always was a split, with some of the best-performing funds charging a management fee of 2% or more—sometimes as much as 3%—and most others keeping their fee under 2%. There also always was some variation in performance fees. Lately, more funds are showing flexibility on management fees, as performance fees also drop.
The best-performing continue to charge high fees, but few see the broad trend reversing itself.
"Most hedge funds aren't worth 2/20, and the smart money has made inroads toward better terms," said Michael Smith, managing director at Global Endowment Management LP, which invests for clients.
When Merchants' Gate Capital LP started in 2007, the stock-focused firm charged management fees of 1.5% or 2%, depending on how long investors locked up their money. In July, it trimmed that to 1.25% and 1.75%. The firm, which manages $2 billion, sought to compete with firms lowering their fees, said a person close to the matter.
Others go further. David Iben, an investment veteran who this year started Kopernik Global Investors LLC in Tampa, Fla., is charging fees of just 0.25% plus 20% of profits for a new "long-short" hedge fund, or one that will both buy stocks and bet against them. A representative for Mr. Iben had no comment.
Even some well-established firms are trimming. Last year, Caxton Associates LP lowered its fees to 2.6% and 27.5%, from 3% and 30%. Graham Capital Management LP cut fees for clients in one fund. Representatives of the firms declined to comment.
"We're seeing the ability to get better fees, especially if you can commit more than $100 million" to a fund, said David Bailin, who helps clients of Citigroup Inc.'s C -1.30%private bank invest almost $5 billion in hedge funds.
A survey of more than 3,000 funds by HFR pointed to investors paying management fees of 1.55% and performance fees of 18.39% of gains as of the first quarter. The survey didn't include special deals for early, larger or long-term investors.
A separate investor survey by Goldman Sachs Group Inc. GS +0.31%said investors were paying management fees of 1.65% and an 18.3% performance fee, on average, as of last year.
A growing number of funds offer "founders' shares," low-cost classes for those who supply a fund with its initial cash.
Harbor Spring Capital LLC, run by an executive who once worked for powerhouse Tiger Global, has a founders' class with management fees that eventually will drop to zero as the firm grows, according to an investor. A Harbor Spring representative wouldn't comment.
More funds also are setting a "hurdle rate," or minimum return they must meet before they charge performance fees.
The Employees' Retirement System of Rhode Island puts 14% of its investments in hedge funds. One firm it invests with, California-based Ascend Capital LLC, recently offered to reduce its management fee and not take a performance fee if returns didn't hit a certain level, according to the Rhode Island state treasurer's office. A spokesman for Ascend declined to comment.
"Hedge funds could make the case for charging a 2% management fee when they were managing much less money,'' said Rhode Island Treasurer Gina Raimondo, chair of the state investment commission. "But do they still need to charge that much when they are now managing billions, not millions?"
Data from Goldman's survey showed 26% of clients had negotiated these performance hurdles, or similar ones, while 17% had negotiated "clawbacks," or measures that require funds to return fees if performance lags.
"In the post-2008 era, we've seen a lot more creativity with respect to fees," said David Z. Solomon, co-head of Goldman Sachs's capital introductions unit, which did the survey.
Even some of those at the vanguard of pushing for better investor terms seem willing to pay high fees for certain big-name funds, an indication of why the shift to lower fees has been gradual. Rhode Island, for example, pays management fees of 1.5% or less for most of the funds it invests in. But it continues to pay performance fees of 25% to invest with funds run by Brevan Howard Asset Management LP and the D.E. Shaw Group, two of the best-known firms in the hedge-fund world.
"The State Investment Commission always tries to negotiate better fees whenever possible, but fees are not the only consideration,'' the treasurer's spokeswoman said in a statement. It "also looks for the best expected risk and return and value for money." Spokesmen for Brevan Howard and D.E. Shaw declined to comment.
A long time coming, to be honest.
Just throw some leverage on there.
This trend is nothing new. From my limited but still decently relevant experience the "norm" for new funds that don't have some sort of institutional backing or high-profile managers are going to be stuck with a 1/20 or something similar, with big concessions being made to large initial investors that might end up getting locked in for a long time should the fund actually succeed.
In general you're seeing a huge push from high net worth clients and even pension plans or other corporate investment vehicles outsourcing their financial advisory, and those guys get paid by making our lives very difficult, since they are more knowledgeable and bitch about pricing quite a lot more than your $2B net worth client would have. With high net clients, all you really need to do is be near the benchmark of your strategy and they're not going to put up a stink... but these investment consultant types will know that you underperformed relative to peers and/or your benchmark, perfect justification to whine about fees. Even AM firms have been getting shit on lately for being at a "ludicrous" 1%, which I find hysterical but nonetheless it happens all the time.
For hedge funds, particularly equity funds, the market for alternative assets has become so saturated and everyone and their mother is capable of pushing out a new equity fund, so you have to compete on price on the low end, as in any other industry. Obviously the higher end funds with legitimate track records of outperformance are going to command a brand premium basically, and those guys can charge their 2/20 into perpetuity, or in many cases go above that.
The more we see passive investing becoming the norm for a vast majority of investors and the obvious risk/reward profile of "the average hedge fund" deteriorating, you will see people weighing the cost of giving up 20% of their upside in exchange for more heavily-invested management and a wider opportunity set for investment. To be honest, if I was a planner of some $50M trust or something, I'd probably not invest in a typical long/short equity fund unless it had a strategy that went above and beyond "buy low, sell high" philosophies. I'd invest in activism I believed was unique, distressed or special situations, etc. Otherwise I'd go to an asset manager I'm confident in and happily pay my 1% while keeping all the additional upside. The more people that think like me, the more you will see funds get squeezed on their fee structures.
The bit about hedge funds underperforming though... all I'll say is there are more than enough funds out there that have done plenty to justify their fees or in most cases make a case that they're too low.
There's a storm coming, Mr. BlackHat You and your friends better batten down the hatches, because when it hits, you're all gonna wonder how you ever thought you could live so large and leave so little for the rest of us.
I've seen some funds that charge almost no management fees but ramp up the performance fee to like 30+. I think that makes some sense. In the legal space it's what's known as a contingent fee.
This format would scare most LPs since it puts the manager at even more of an economic incentive than the normal hedge fund manager, so you'd be very afraid of volatility here and the manager blowing himself up to make a killing one year.
And given that most amounts invested in HF are relatively small compared to a standard AM. A bank might give $1B to an asset manager, but in most cases HFs are taking in only 8 or low 9 figure flows from each LP, so on a cost-benefit for these investors, the bigger their investment is going to be, the more they care about the flat expense fee and capital preservation. I think the 0%/30% might work well with a high-profile fund launch where the founders will already be wealthy and compose most of the AUM originally. People would probably pay up for the talent, and the lack of management fee wouldn't hurt operations or piss off LPs in a down year.
That pretty much describes the funds I've seen this for.
What are your are views on managed account platforms? I've read from a few MS and GS HF industry reports that coinciding with pressures on fees the switch to managed account platforms by HF's as ways to attract capital has been noticeably increasing. However, the amount of capital being allocated via managed account platforms only take up about 1% of the entire HF industry, their use is expected to increase by almost 60 percent in each of the following years (don't quote me on that, but its somewhere in that ball park).
I'd love to hear some consultant call up Renaissance and complain about their fees. I'm pretty sure they would get promptly hung up on.
At a very fundamental level, it only makes sense to pay high alternative investment fees for ACCESS to strategies which are difficult to execute and potentially attractive (whether due to high returns, low correlation, whatever).
Again, the key word here is ACCESS. I can open an IB account and in a fraction of my time manage a long/short equity portfolio. Pretty much anybody can do this. For that reason, long/short equity fee structures are unequivocally going to decline, and likely significantly, over the long term. The supply glut of long/short managers, and the mediocre net performance of the strategy as a whole, is just a catalyst that is helping that along.
Private equity, PIPE, distressed, bond funds, global macro, etc, are strategies which are very difficult to ACCESS, and thus very difficult to replicate. So one should expect fees to maintain better in those areas than they are in the l/s equity and long-biased equity world (which it seems a lot of folks on this board conflate with the entire hedge fund world).
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