Hedge Fund Margins Keep Shrinking — But Investors May Still Find Them ‘Frustratingly High’

Most industries would be “quite envious” of hedge fund margins, according to Barclays.

Illustration by II

Illustration by II

Hedge fund income is being squeezed by falling management fees and steady fixed costs — but margins remain enviously high, according to Barclays.

The bank’s strategic consulting team studied data from hedge funds with about $415 billion of total assets and found that management fee margins fell to 40 percent last year, from 53 percent in 2014. Investors may still find these margins “frustratingly high” and demand even more fee concessions, Barclays said in a new report looking at the hedge fund industry’s financials.

Hedge funds often rely on management fees to “subsidize performance fee income” during years in which they produce weaker returns, according to the report. Barclays said that “most other industries would be quite envious” of hedge fund firms’ 40 percent margins for management fee income.

Performance fees have been “choppy” for hedge funds over the past three years, said Barclays, with 2018 being particularly difficult because of the drawdown in the fourth quarter. Alternative-assets data tracker Preqin recently estimated that hedge funds produced three-year annualized returns of 5.5 percent through September, lagging the 10 percent gains from the Standard & Poor’s 500 index.

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Management fees in the hedge fund industry have been under pressure.

Median income from such fees slid to 102 basis points last year, from 126 basis points in 2014, according to the Barclays study. That translates into a decline of about six basis points year-over-year, with half of the decline due to degradation to hedge funds fees, the bank said.

Hedge funds charge median management fees of 110 basis points, while long-only and risk-premia strategies are significantly less expensive, according to the report. Long-only funds charge 57 basis points, while investors pay a median 62 basis points for risk-premia managers.

Falling fees have hurt profits, as fixed costs in the hedge fund industry have stayed around 60 basis points over the past five years, according to Barclays.

Barclays also looked at the health of hedge funds by studying productivity based on headcount.

Total revenue — including management and performance fees — measured per employee shows that hedge funds with at least $10 billion of assets are “far and away” the strongest, the bank’s study found. Each employee at such large managers produces an average $1.3 million in revenue, or about 36 percent more than hedge funds with $500 million to $2 billon of assets under management.

About one-third of hedge funds produce total revenues of less than $500,000 per head, a level that puts their sustainability at risk, Barclays said.

“It stands to reason that the largest HFs are able to stabilize their total revenue per headcount by virtue of their diversified product set that generates performance fees regardless of the different market environments,” Barclays wrote in the report.