Mean hedge fund performance fees have slowly been dropping below the perceived industry standard of 20% following several years of disappointing returns and growing investor dissatisfaction from institutions such as pension funds with the level of fees charged. Despite the downward trend in performance fees, Preqin’s Hedge Fund Analyst database monitors approximately 200 single manager hedge funds that charge a performance fee greater than 20%.
The performance fees charged by this group of funds range from 21% up to 60%. Funds which charge greater performance incentives offset higher performance fees with reductions on the management fee, with mean management fee charged by this group of funds standing at 1.51% (significantly lower than the industry wide mean of 1.64%). A fifth of all these high-performance fee funds charge no management fee at all. Forty-six percent of these high-performance fee funds employ either a high watermark or a hurdle rate. This is a higher proportion of funds with hurdles or HWMs to the rest of the industry, indicating that these funds which charge greater than 20% performance fee incentives couple this with more rigorous performance objectives.
Do these funds which charge higher fees generate stronger returns for their investors? Annualised over two-, three-, and five-year periods these funds which charge fees greater than 20% consistently outperform those funds with performance fees of 20% and lower (for instance annualised returns over a 2-year period is 6.25% for high performance fee funds compared to 4.18% for funds which charge 20% or lower performance fees). When examining the Sharpe-ratio of funds charging over 20% performance fees compared to the fund with 20% or lower performance fees, the Sharpe-ratio is three times higher than the wider hedge fund industry; 1.2 compared to 0.42 for the wider hedge fund industry. These figures show that funds who charge performance fees greater than 20% are able to create greater risk adjusted returns.
Funds which charge performance incentives of greater than 20% buck the current trend towards lower fees in light of growing investor calls for fee reduction and poor performance in a difficult returns environment. With some funds even charging up to 60% performance fees can managers attract investors? The returns generated by these higher-performance incentive vehicles are certainly attractive as they consistently outperform funds which charge lower fees over all time periods, as well as providing stronger risk-adjusted returns. This increased potential for stronger performance, coupled with the increased occurrence of lower or no management fee, can make these funds which charge performance fees over 20% attractive to those investors which seek high returns and are willing to reward managers which provide demanding performance objectives or hurdles which have been satisfied.