Is Investor Pressure the Main Driver Behind the Reduction in Hedge Fund Fees? - June 2014

by Sasha Pickup

  • 18 Jun 2014
  • HF

In recent times the traditional “2&20” hedge fund fee structure has become increasingly uncommon and, according to data from Preqin’s Hedge Fund Analyst, only 31% of funds currently utilize this fee structure, despite it once being a rigid industry standard that was left unquestioned for years. The financial crisis, investor pressure and the need to attract new capital in an increasingly competitive market have been the driving forces behind the changing fee structures. The mean management and performance fees for all hedge funds currently stand at 1.55% and 19.03% respectively. 

Preqin data illustrates that the mean performance fee for new fund launches has decreased from 19.03% in 2007 to 18.86% in 2014, and the mean management fee has fallen by a proportion of 14% during the same period from 1.63% to 1.40%. There has been a more consistent reduction in management fees, compared to performance fees which have seen fluctuations year-on-year despite an overall decrease. The adoption of provisions such as high water marks and hurdle rates by managers has lessened the pressure of reductions in performance fees and this may also point to investors being willing to pay for positive returns. 

Investor pressure and the need for fund managers to attract new capital in an increasingly competitive market are likely to have contributed to the overall decrease in fees being charged. Large institutional investors, who are more knowledgeable about the industry and typically better equipped to negotiate, are often able to exert significant amounts of pressure on managers to lower their fees. With increasing levels of capital being allocated into the industry and with the growing number of hedge funds, fund managers are attempting to compete among their peers for capital and are using lower fee structures in an attempt to entice more investors. 

According to the Preqin investor survey compiled for the 2014 Preqin Global Hedge Fund Report, 59% and 49% of investors noted an improvement in management fees and performance fees respectively in 2013. However, only 21% of investors stated fees as a key factor they assess when evaluating hedge fund managers. This could indicate that the key driver behind the overall reduction in fees is the increased competition within the market, rather than direct pressure from investors. 

It is interesting that the mean management and performance fees of CTAs are a lot higher than those of hedge funds, standing at 1.68% and 20.49% respectively. However, so far 2014 has demonstrated the lowest average fee structures for new CTA fund launches since 2000, with the mean management and performance fees of new funds standing at 1.32% and 19.38%. This can be explained by the below expected returns of CTAs in recent years forcing managers to reduce fees. 

It will be interesting to see if fee structures, especially management fees, continue to decrease over the coming 12 months. It may be that some fund managers are reluctant to further decrease their fees as doing so could indicate that the fund is of poor quality. Furthermore, only 21% of institutional investors state fees as a key fund selection factor, behind other factors such as returns, track record, management experience, strategy, risk profile and transparency. Therefore, management fees could remain fairly constant for the foreseeable future, and we may see significantly more founders’ share classes with reduced fees. 

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