Hedge fund managers are finally finding ways to change the
long-held perception that the way they charge for their
services is unfair.
While the actual sticker price charged by many hedge fund
firms has been declining for some time albeit not as
much as some investors would like experts say managers
are now changing not just their prices, but the
industry-standard fee structure itself. With investors having
soured on hedge funds in recent years owing to a combination of
lackluster performance and high prices, managers are looking to
novel structures to attract new clients
and keep existing ones.
These methods can range from offering sliding-scale fees
such as an upfront fee break for so-called
founding-class investors for taking a chance on a new firm
to multi-year incentive allocations that are based on
performance in a given year, according to Steven Nadel, a
partner at law firm Seward & Kissel who works with hedge
The changes may be working: A recent Preqin survey of hedge
fund managers said 30 percent think the fundraising environment
today is tougher than it was a year ago, compared with nearly
50 percent who said the same a year earlier.
Investors are happy that hedge funds have responded to
their concerns, says Mark Doherty, a managing principal
at hedge fund consultant PivotalPath.
Hedge fund managers have historically employed the so-called
2-and-20 fee structure, in which they charge clients a
management fee of 2 percent of assets and take a 20 percent cut
of the years performance gains.
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But that structure has come under fire from investors who
feel it provides incentive for managers to grow their asset
base at the expense of performance, which allows them to view
their management fee as a profit center.
Theres been pushback on management fees
[charged] by some of the big firms, says Nadel. It
arguably is a disincentive to earn your carry because
youre already making a lot of money.
As a result, fund managers are looking to new fee structures
to alleviate investor concerns.
One option, according to Nadel, is the sliding-scale fee, in
which the management fee decreases as the assets under
management increase. Allocators, as a result, have an incentive
to invest more money in a hedge fund that offers this fee
Nadel says between 20 and 25 percent of hedge fund launches
over the past year are offering this fee structure.
According to Doherty, this strategy is common among startup
hedge funds that want to impress potential clients with a
different strategy. Its also more common, he notes, with
hedge funds that can easily raise $500 million or more.
Funds that raise less than $500 million from their founding
class often flip this strategy on its head, according to
Doherty. Instead of offering a preferred fee to investors when
the assets under management increase, these funds offer
incentives for investors to be among the first to allocate to
Another strategy, according to Nadel, is to offer a fee
structure that takes into account the changing nature of hedge
What weve been seeing, especially this year, is
a bit of an increase in managers who are engaging in strategies
that are long-term buy-and-hold or activist in nature,
More funds are now offering multi-year incentive
allocations. Instead of charging the same rate for management
and performance every year, that rate is adjusted yearly to
reflect returns over the period of the investment.
For example, if an allocator invested $1 million in a
strategy that returned 10 percent in its first year but lost 50
percent the following year, the hedge fund manager
wouldnt collect $20,000 in fees for the first year, but
would instead adjust its initial fee to reflect the loss in the
second year of the strategy by giving investors a fee
According to Nadel, this strategy better matches incentive
compensation with investor liquidity.
Capital is more stable, Doherty adds.
Theres value to that.