“1.75 and 21.93”: The new, new, new fee structure?

Fees 10 Nov 2009

revisionLike Democrat versus Republican, Communism versus Capitalism or Yankees versus Phillies, discussion and debate over fees, their justification and their pending demise is perennial and never-ending. With each market downturn and never-again wave of investor revolt, the banter over whether alternatives managers can and should be exorbitantly charging for their services inevitably heats up.

Certainly AllAboutAlpha.com is just as guilty when it comes to focusing on and feeding the fee frenzy. Only a few weeks ago we published this post about the yet-again demise of 2 and 20 in light of the new era of reduced returns – and reduced interest – in hedge funds.

So it caught our attention when Tabb Group published a report last week noting that while they too expect management and performance fees to steadily decline over the next couple of years, that according to their poll of hedge fund managers 1.75 and 21.93 are actually the new 2 and 20.

“Many wouldn’t be surprised to know that ‘2 and 20’ is still alive and well,” Matt Simon, TABB research analyst and author of the new study, “US Hedge Funds 2009: Fees, Redemptions and Managed Accounts,” noted in a statement accompanying the release of his report. “When weighted by assets under management, the reality is ‘1.75% and 21.93%’.”

TABBHF09_Exhibits4-5

Weird numbers, to be sure, and certainly not that big a jump from the steadfast “2 and 20” that seemingly won’t go away. Also better than the 1.6 and 17.2 recently predicted by London-based research firm Preqin, though for good reason, according to Tabb: Investors are still committed to paying for alpha, if they think they can get it, but they are less tolerant paying for beta.

That’s why management fees are probably going to slide south over the next two years, likely at a faster pace than performance fees, according to the survey, which was compiled from conversations with 62 different hedge fund managers between May and July 2009, representing a combined US$127 million in assets.

In other words, if performance doesn’t recover from its post-crisis dip and resume, investors aren’t going to be willing to cough up 20% anymore.

“With a limited supply of capital at hand, hedge fund managers are in a weak if not a precarious position to defend against fee reductions,” the report said.

Not only are managers going to be collecting less fees, they’re apparently going to be spending more on setting structuring separate managed accounts for their clients. The report also honed in on the managed accounts phenomenon and investors’ focus on transparency, liquidity and flexibility as the key drivers pushing them into them.

TABB Group estimates that assets in the industry invested through managed accounts will reach $790 billion by 2011, up from $468 billion in 2009. However, the “cost and administrative benefits to keeping up with portfolio transactions” will continue to outweigh the benefits of the managed account platform, noted Simon.

TABBHF09_Exhibit23

If there was a silver lining anywhere in the report, it was that managers are much more willing than before to be flexible on lock-ups, either doing away with them outright at one end of the spectrum, or adjusting them in exchange for lower fees at the other end.

No matter what, the report seems to make clear that investors – not managers –are in the driver’s seat. Whether or for how long it continues remains to be seen, but certainly there’s a lot less knocking on managers’ doors these days, no matter how good the track record.

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2 Comments

  1. nick gogerty
    November 11, 2009 at 10:27 am

    One interesting thing for fees structures would be for funds to offer a discount based on a lock-up with a pre-determined early exit penalty. For example a 1% fee against a 6 year lock-up etc.

    The risk of course is that the investor market may see this as signaling fund weakness, but it would get the “how much do you trust me and my process.” argument out on the table.

    This would serve both the fund and the investor in the long run as it would make it less likely the investor would selll the lows in the fund, would provide more stability operationally for the fund and would better the investors returns over the long run.


  2. Richard Tomlinson
    November 11, 2009 at 2:08 pm

    Interesting research and although I have not seen a full copy of the report the exerts I have seen quoted in press articles does seem to make sense with my experiences. I chaired a conference organised by The Hedge Fund Journal in London last week on managed accounts and what role they can play moving forward. A number of the discussions certainly supported the findings of the report, namely:

    1) Investor preferences placing higher weight on transparency, liquidity, control and governance
    2) Assets flowing onto managed accounts are likely to increase significantly over the next year or two


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