Since the onset of the financial crisis in 2008 the issue of fees has become very prominent in the fund of hedge funds industry. Many dissenting investors have been questioning the fee models of these managers against a backdrop of underwhelming returns. However, despite the rising interest in ’40 Act funds, investors are still attracted to the diversification benefits provided by funds of hedge funds and a seeming willingness on behalf of these managers to negotiate on fees.
According to data from Preqin’s Hedge Fund Analyst, the mean management fee across fund of hedge funds vehicles stands at 1.20%. An average fee of 1.25% was levied by funds launched in 2005, only five basis points less than the mean management fees for funds launched year-to-date in 2014 (1.30%). In the intervening ten years it is clear that the financial crisis in 2008 has had some impact on management fees. In the three years before the crisis (2005-2007 inclusive) the average management fee was charged at 1.18% while the three years following the crisis (2009 to 2011 inclusive) registered a lower mean fee of 1.16% across fund of hedge funds vehicles raised during that time (including a 1.05% mean fee charged by 2011-incepted funds). However, since 2011 there has been a year-on-year increase in the mean management fee being levied by new funds of hedge funds, with a 1.21% average charge in 2012, 1.27% in 2013 and 1.30% year-to-date 2014.
Performance fees charged by multi-manager funds hit their peak in 2007, a boom year for fund of hedge funds launches and capital inflows, with an average fee of 10.5% being charged to investors. This is the only year over the last ten-year period to have registered a mean incentive fee of more than 10%. Although this fee rate is usually associated with being the fund of hedge funds industry standard, the actual overall mean performance fee stands at less than 9% (8.97%).
Since the 2008 crisis there has been a significant fluctuation in the average performance fee being charged. For example, the performance fee dropped significantly by 72 basis points from 8.76% charged on average by 2009-incepted funds to the 8.04% average fee levied in 2011. Then, after a sharp hike to 9.76% in 2012, this was subsequently reduced by a greater margin of 181 basis points to 7.95% year-to-date 2014. One reason for the recent reduction in performance fees is the competition faced by fund of hedge funds from structures such as multi-manager alternative mutual funds which rarely charge any performance fee, thus leading fund of hedge funds to reduce the fee they would usually levy in order to retain or attain investment.
While management fees have only slightly changed post-2008, performance fees have been fluctuating to such an extent that their average is now lower than it has been since the institutionalization of the industry. It has been suggested that investors’ disenchantment with fees, lock-up periods and other hedge fund terms is leading them to seriously consider alternative fund structures such as multi-manager ’40 Act funds that largely dispense with performance fees. Therefore, the fee model being charged to investors is an increasingly important consideration for fund of hedge funds managers in their dealings with new or existing investors.