This content is from: Portfolio

The Death of 2 20?

Just 38 percent of single manager hedge funds charge the perceived industry standard of 2 & 20, according to a recent Preqin survey.

Pity the poor hedge fund manager. Thanks to the recent market meltdown, they now have to make do with lower fees than in the past.

According to a study by London-based Preqin, the average management fee is 1.65 percent while the median fee — the same number of hedge funds charge more and less — is closer to 1.50 percent. And while the median performance fee is 20 percent, the mean — average— is 18.89 percent. In fact, just 38 percent of single manager hedge funds charge the perceived industry standard of 2 & 20, according to Preqin, which surveyed 900 funds in both the second quarter and the end of the fourth quarter of 2009.

Interestingly, Preqin found that the percentage of funds charging between 1.5 percent and 1.99 percent surged to 33 percent from 22 percent from the second to fourth quarter last year. During the same period, the percentage charging 2 percent dropped from 54 percent to 40 percent. Just 4 percent charge more than 21 percent.

Meanwhile, about 8 of 10 managers charge a 20 percent performance fee. Another 4 percent charge more while the rest charge less. “Hedge fund managers are becoming more flexible with their fee structures by either charging lower management or performance fees or reducing both in an attempt to attract investors and retain a competitive advantage,” Preqin noted in its recent report.

Obviously, as hedge funds tried to rebuild after the market meltdown, the investors were able to hammer out a pretty good deal. But, don’t exactly fret for the hedgies. When they used to charge 1 percent, their argument was that this fee would pay the firm’s bills and the performance fee was their profits, thus aligning their interests with their investors. However, as a number of the larger hedge funds regularly outperformed their peers and the overall market, they were able to command much higher management fees, which became a profit center alone.

Jim Simons’ Medallion fund now charges 5 percent, Paul Tudor Jones II’s BVI Global charges 4 percent and a number of funds charge 3 percent, including Bruce Kovner’s Caxton Global Investors, which also charges a 30 percent performance fee, and Louis Bacon’s Moore Capital, which levies a 25 percent performance fee. At the market’s peak, Kovner and Bacon were each bringing in around $250 million to $300 million in management fees alone. So much for the management fee just being used to pay the firm’s bills.

Interestingly, these days the fees are being negotiated in conjunction with other issues. For example, the survey found the lower the fees, the longer the lock-up period. Here is the data that most hedge fund managers will no doubt latch on to, however. The survey found a strong correlation between performance fees and the returns of single manager hedge funds over a 12 and 24-month period through November 30, 2009. The data clearly shows that single manager hedge funds that charged a higher performance fee produced higher returns for their investors, according to Preqin. The converse was also true.

No doubt the lesser performing funds were the ones who were forced to cut fees. However, I have less of a problem with top performing hedge funds charging higher performance fees. This is the Eat What You Kill mentality among hedge funds that seems to work. I think investors should revolt against those funds with billions under management racking up lousy or mixed returns that charge 2 percent or 3 percent of assets under management. They are the ones with the least skin in the game.

Stephen Taub Stephen Taub , who has covered the hedge fund industry for 30 years, is a contributing editor to Institutional Investor and Absolute Return-Alpha magazines.

Related Content