Double-digit returns among a third of hedge funds weren’t enough to stave off performance fee erosion
It’s been years since hedge-fund industry participants had to swallow a particularly bitter pill: the traditional “2 and 20” model was no longer working. As market-based beta performance provided handsome returns for investors, critics questioned the 2% management fee, asserting that managers should earn their keep and generate profits from performance fees.
But fast forward to 2019, and the pressure for hedge fund managers to cut fees has not gone away. In fact, it seems that most of the compression has occurred with respect to performance fees.
Citing figures from Eurekahedge, Institutional Investor reported that about one third of hedge fund managers were able to produce year-to-date returns in the double digits through November 2019. Overall, global long-short equity strategies returned 8.64%, while global macro and fixed income hedge funds hit 7.33% and 6.82%, respectively.
In spite of that, average performance fees dropped significantly. Between 2018 and 2019, fees among North American hedge funds dropped from 16.24% to 14.81%. European hedge funds’ fees declined from 14.36% to 12.63%, and Asian hedge funds saw their performance fees plummet from 18.07% to 15.59%.
Far steadier were hedge fund management fees, which were reportedly 1.27% on average for North American hedge funds in 2019. That’s only slightly lower than their 2018 average in 2018; in 2009, the average hedge fund in North America commanded a 1.61% management fee.
The apparent pressure on hedge fund fees comes amid a continued exodus of investors losing faith and patience. Based on reported Eurekahedge figures, investors pulled US$131.8 billion overall in 2019, US$72.7 billion of which came from long-short equity strategies. Managed futures strategies shed US$12.2 billion, despite finally breaking a multiple-year slump with good numbers in 2019. Macro strategies shed US$18 billion, and multi-strategy funds saw US$21.4 billion in outflows.
Performance fees are seen as a way to align the interests of hedge fund managers and investors, but focusing on those fees isn’t the only way to achieve that alignment. In a paper released last year titled In Harmony, the Alternative Investment Management Association (AIMA) found that hedge fund managers are also exploring other options such as:
- Providing lower fund fee structures to early-stage investors;
- Offering institutional share classes that give certain preferential terms to valued investor groups; and
- A tiered management fee system that ratchets down fees as fund AUM grows
