Haggling with hedgies: Investors have the upper hand, finally

Hedge funds' recent poor performance, along with a sluggish economy, has finally given investors the upper hand in negotiating fees on these historically high-priced alternative investments. After more than a decade of increasing performance and management fees, hedge fund managers have had to dial back what they're charging, according to a report released by Preqin Ltd., a London-based alternative-investment consulting firm. The 2% management fee and 20% performance fee that became the industry standard a few years ago is now down, on average, to a 1.6% management fee and 17% performance fee, according to the report, which included a survey of nearly 400 hedge fund managers in April and May. “The bottom line is, the 2-and-20 fee structure is outdated and doesn't hold anymore,” said Amy Bensted, managing analyst in Preqin's hedge fund research group. The main force behind the trend toward lower fees is pressure from investors in an environment when hedge funds have lost some of their luster, she said. “Last year, lots of hedge funds did poorly, so many of them have to lower fees to attract new investments,” Ms. Bensted said. According to the survey findings, 40% of hedge funds are still charging annual management fees of 2% or more, and 33% are charging between 1.5% and 1.99%. Twenty-four percent of managers are charging between 1% and 1.49% management fees, and 3% of managers are charging a management fee of less than 1%. Performance fees have held up better than management fees, with 72% of managers still taking 20% or more of a fund's gains. Twenty-one percent of managers are charging between 10% and 19.9%, and 8% of managers are charging performance fees of less than 10%. There is also a correlation between cost and hedge fund strategy, according to Ms. Bensted, who said that some strategies will always command higher fees. The long-short equity strategy, for example, is the most common hedge fund strategy and has therefore seen a lot of pressure on fees, which now average 1.5% management fee and 18.6% performance fee. Event-driven and special-situations strategies, by contrast, are setting management fees at an average of 1.7%, but performance fees are holding steady at 20%. The location of the fund also has an impact on fees, which Ms. Bensted described as a reflection of the maturity of each market and demand for investors within each market. The average management fee charged by hedge funds based in North America is now at 1.5%, and the average performance fee is 16.3%. This compares with Europe, where the average management fee is 1.7%, and the average performance fee is 17.9%. In Asia, the newest hedge fund market, management fees average 1.5%, and performance fees average 15.8%. Going forward, Ms. Bensted said, the trend likely will be dictated by the performance of hedge funds, but she doesn't anticipate that fees will drop much lower. “Depending on the performance and the individual strategy, the average management fee could drop a bit more to around 1.5%,” she said. “For the time being, investors have all the power.”