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Blockchain, Artificial Intelligence Pave Way for Lower Private-Equity Fees

Private-equity and hedge-fund managers that use new technologies are charging less and putting competitive pressure on peers, according to new research.

  • Staff

Alternatives managers are under pressure to lower their fees – and it’s not just coming from investors.

The adoption of technology, including blockchain, artificial intelligence, and big data, has made it possible for private-equity and hedge-fund managers to reduce their fees, placing competitive pressure on rivals still using a traditional fee model, Wulf Kaal, associate professor and director of the private investment fund institute at the University of St. Thomas in Minnesota, said in a recent paper.

The majority of private fund advisers that use such technology in their operations or strategy have "a substantially lower fee structure than those who do not use them,” Kaal wrote. “As the use of blockchain technology grows in the private investment fund industry, the pressure on the fee structure is likely to continue to grow.”

Hedge-fund fee structures have been shifting over the past decade in favor of investors demanding better terms because of inadequate performance, or because they’re large enough to negotiate a special arrangement in areas such as hurdle rates of return, according to the paper.

Now new technology is making it possible for asset managers to conduct investing transactions more efficiently, Kaal said. He cited examples including Numerai’s artificial intelligence hedge fund, which reduced overhead costs by eliminating human capital, and Northern Trust’s collaboration with IBM earlier this year to “increase the efficiency, transparency, and speed of private equity transactions” through the commercial use of blockchain.

Because blockchain technology “facilitates a seamless and efficient calculation of management fees per transaction,” fund managers can charge based on the number of transactions required by their investment strategy, according to Kaal. He said the new method is undermining the traditional model that charges a 2 percent management fee based on assets plus 20 percent of investment profits.

Even if managers don’t use per-transaction fee models, he added, they can still charge less because of the lower overhead costs that result from using new technologies. LendingRobot’s fully automated hedge fund, for example, charges a 1 percent management fee and maximum 0.59 percent fund expense fee because its business model “removes the investment adviser, overhead costs, and legal fees associated with each investor agreement,” according to the paper.

The “meteoric rise” of blockchain technology, along with its application using artificial intelligence and big data, “serve as prominent examples of the impending seismic shifts in the private investment fund industry,” Kaal said. “As the use of modern technologies increases in the industry, the fee structure is likely to be further affected.”