Hedge fund fees have been trending downward for six years, but could they vanish completely? And what kind of impact could this have on the industry?
Coming soon to a hedge fund near you: No more performance fees.
That's right, the industry that made high fees and expenses fashionable is starting to drift back down to Earth.
In typical hedge fund industry style, this trend is difficult to quantify, but the examples continue to sprout up as hedge fund managers find creative new ways to justify separating from the herd.
Eclipse Capital Management, which charges 1.5% on assets and 15% on performance for style purists, has rolled out a momentum strategy for a simple 1.25% management fee.
“We can offer the pure momentum strategy for just the management fee because it doesn't have the same capacity constraints as our other strategies,” Eclipse spokesman Nigel Ekern said.
Obviously, capacity can be an issue, but with just $150 million in total assets under management, one can't help but wonder if it was capacity or basic market forces that drove the decision to offer a no-performance-fee strategy.
At Gotham Asset Management, where the $5.5 billion under management is split evenly between hedge fund and mutual fund portfolios, it is actually cheaper to invest in a hedge fund than it is to invest in a mutual fund with a similar strategy.
The firm, which specializes in long-short equity strategies, gives hedge fund investors the option of paying a 2% management fee or a 1% management fee combined with a 10% performance fee.
Meanwhile, the $1.6 billion Gotham Absolute Return Institutional Fund (GARIX) has an expense ratio of 2.25%, which is 25 basis points higher than that of the hedge fund.
Gotham's co-chief investment officer, Joel Greenblatt, said among the hedge fund investors, about half still opt for the fee structure the includes the performance fee.
“It is my opinion that our mutual fund offerings are every bit as good as our private offerings,” he said. “Plus, with the mutual fund, you get daily liquidity.”
At the $450 million V2 Capital, founder and chief investment officer Victor Viner eliminated the 15% performance fee last year and is now offering management fees of between 60 basis points and one percent, depending on the size of the account.
According to Hedge Fund Research Inc., hedge fund fees across the industry have been trending downward since 2008, when the average performance fee peaked at close to 20%.
The average stated performance fee is now closer to 18%. But you have to look at this kind of macro data in the context of how difficult it is to get any hard and useful numbers out of the hedge fund space.
The biggest issue is that hedge fund reporting of any information still is largely voluntary.
Just as it is not uncommon for a hedge fund with poor performance to delay reporting those numbers to one of the handful of data-gathering firms, most managers are not falling over themselves to announce lower fees.
“There are headline fees that get reported to databases and used in documents, but within almost every set of documents, the manager has flexibility on fees,” said Meredith Jones, director at consulting firm Rothstein Kass.
“Flexibility on fees is becoming a lot more common than it was a few years ago,” she added. “Up until 2008, most managers were able to hold the line on fees, regardless.”
While it might seem counterintuitive not to boast of lower fees, such is the world of hedge fund investing, where discounts can sometimes be construed as weakness.
“Most of the top hedge funds have so much money they're giving it back to investors, and those top guys are never going to lower their fees,” said Bradley Alford, chief investment officer at Alpha Capital Management.
“The big guys will laugh at you if you ask them to cut their fees,” he added. “Why would you take a cut in pay, unless you had to?”
One big reason for the trend toward lower fees is the booming growth of alternative strategy mutual funds, which offer most hedge fund styles along with daily liquidity, lower fees, lower minimums and some semblance of portfolio transparency.
Morningstar Inc. now tracks more than 450 liquid alternative funds across a dozen subcategories, compared with 116 such funds 10 years ago.
Assets in the category have grown by nearly 570% since 2004 to more than $150 billion.
For some in the hedge fund space, this is all the evidence needed to adapt and embrace the new reality that to prosper is to evolve.
Meanwhile, there is still hope for those hedge fund managers stubbornly clinging to their performance fees, because it's clear that some investors just won't have it any other way.
