Hedge fund fees rise as industry demand returns
Hedge fund fees have been the focus of intense discussion in recent times, but certain investors say that better managers deserve the fees they earn
These are possibly a hedge fund manager’s favourite words: “Two and twenty”.
Together, they explain how hedge funds charge their clients – by taking 2% of fund assets plus 20% of profits. Just as important, though, they also explain why some successful managers are among the world’s richest entrepreneurs. But during the financial crisis, you could almost make an allocator’s blood boil, just by saying ‘two and 20’.
For decades before, allocators had accepted paying the fees that made managers rich. Day-one investors in AW Jones & Co, the world’s first hedge fund, did not mind as Alfred Winslow Jones made over 5,000% in his first 20 years, according to industry biographer Sebastian Mallaby.
Many hedge fund allocators accepted that, up to 2007, you had to pay for talent.
“We were happy to hand over 20% of the gains, because the gain in 2007 was 10%, and that was double what we made on the S&P 500 and better than fixed income, too,” says one.
But then in 2008, managers lost 19% on their investments, so fees and how they are collected came to the top of some investors’ agenda. Managers moved quickly, by cutting fees in many cases.
Ansgar Guseck, senior partner at Cologne-based allocator Sauren, says: “The performance fee should give the right incentive to the manager. It should not be a tool to maximise only the profit of that manager.”
For funds in the most trouble, a quick shift to ‘one and 15’ was not unusual, although sometimes investors had to agree to commit for long periods at the same time.
Other managers cut their incentive fees even more sharply, but unusually asked investors to pay them before the fund had made up for all past losses. Some funds – and funds of funds – installed mechanisms that would release charges back to clients if the products later underperformed.
By the start of this year, database Eurekahedge found that the industry’s average fee levels had dropped to 1.5% and 17.7%.
There has been further poor news on performance this year. By August, managers had not even managed to make half the gains of the S&P 500 (4.6% versus 12%), so investors would have made more in US shares by buying far cheaper ETFs. Furthermore, according to analysis published by Goldman Sachs, hedge funds lagged the average large-cap mutual fund’s gain of 9.9%.
Only one in every 10 hedge funds has beaten the US market, and one in every five lost money.
By August, the 50 US stocks that hedge funds were relying on most heavily – as suggested by frequency of mentions in managers’ June 13F filings analysed by Goldman Sachs – were up only 9%. They fell twice as sharply as the S&P 500 over the second quarter.
After all this, you might expect there to have been further widespread pressure on fees this year.
But the result has not been irate investors – quite the opposite, in fact. Analysis Eurekahedge conducted found by May fees were actually on the rebound, at 1.6% and 18.3%.
Analysis of the eVestement/HedgeFund.net database finds almost $1 in every $10 in the industry now attracts an incentive fee of more than 22%. Morningstar’s tables show at least five funds retain 50% of their gains. One, the Lyxor/Weiss Multi-Strategy Fund Ltd, increased to this level in April, although it eliminated its fixed fee at the same time.
But paying 50% is far too hot for some. When the head of one Swiss family office saw the 50% rate, he simply said: “Wow!”
Ronnie Wu, Asia CIO at Swiss allocator Gottex, says: “It is hard to imagine paying such fees, as the risk reward is not favourable. We do not rule it out, but we would need to see a really unique strategy, or a highly capacity-constrained fund, to justify such fee structures.”
But generally, it seems, allocators are comfortable with their managers, and fees.