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Do Better Performing Hedge Funds Hold the Power to Charge Higher Fees? – October 2015

by Boris Friedman

  • 26 Oct 2015
  • HF

Two and twenty has long been the most common fee structure charged to hedge fund investors, employed by 40% of funds. Recently, hedge fund fees have been a significant concern among investors. According to Preqin Investor Outlook: Alternative Assets, H2 2015, 36% of hedge fund investors frequently decide not to invest in a fund due to its fees, suggesting that investors are increasingly more interested in funds with lower performance fees.

Funds charging over 20% in performance fees have performed the best this year to date, gaining 3.04% as of August 2015; this compares to funds charging less than 10%, which have lost 1.84% YTD. Funds charging a performance fee in excess of 20% have also performed the best over a two-, three- and five-year annualized time span, with returns of 8.55%, 11.65% and 11.59% respectively. Meanwhile, funds charging 10-20% in performance fees have achieved the lowest returns over the same period on an annualized basis. It is also interesting to note that the less than 10% fee group has outperformed the 20% and 10-19.99% bracket on a two-, three- and five-year annualized basis.

Looking at volatility, funds charging more than 20% have been the least volatile, with a five-year volatility of 4.57%. Meanwhile, funds with a performance fee under 10% have seen a considerably higher 7.69% five-year volatility. The volatility statistics suggest that investors may be paying higher fees for the benefit of more consistent returns; while the performance broken down by fee bracket provides less clear conclusions, it does not appear that stronger returns necessarily yield for managers the ability to increase fees.

Overall, funds with higher fees have performed the best on average over the longer term. This could suggest that their ability to produce superior long-term returns drives their ability to charge higher fees. However, their counterparts with fees of less than 10% have performed better than those in the 10-20% bracket. Funds with the best performance have the highest fees, suggesting that investors are willing to pay for such returns. However, despite there being greater volatility among funds with lower fees, good performance can still be found.

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