HF fee squeeze: Not such a new thing

As this article from Pensions & Investments points out, the long-awaited drop in hedge fund fees may finally have arrived.  Although performance fees – a significant portion of overall fees – have recently dropped to zero percent across a wide swath of funds, P&I observes this week that:

“Some hedge fund managers — including Renaissance, Citadel and Diamondback — are heeding the call from institutional investors, setting up new funds, share classes or better-priced offerings.”

While fee pressure may appear to be a relatively new phenomenon, research in the past has shown that in aggregate, investors have been forcing down the fees charged by higher risk hedge funds.  A study written in October 2008 by Gavin Cassar at Wharton and Joseph Gerakos of the University of Chicago found…

“…a positive association between the quality of internal controls and the performance fees rewarded to managers, consistent with investors protecting against potential financial misstatements by placing less emphasis on the reported performance when internal controls are less likely to detect or prevent managers from manipulating reported performance.”

In other words, investors have always put pressure on riskier funds by forcing them to charge lower performance fees.  However, unlike the current flavor of hedge fund investor activism, this pressure seems to have resulted from investors simply voting with their wallets and avoiding riskier, unproven funds – thus forcing them to lower their  fees to attract capital.

These charts from the paper confirms data we presented in this post a few months ago, showing that less than half of all funds actually charge a 2% management fee…

Although most hedge funds don’t actually charge 2% in management fees, a 20% carry really does seem to be the norm.  This suggests that although the study revealed pressure on the performance fees of funds with poor internal controls, that pressure only seems to affect a small portion of all hedge funds.

A survey release by Preqin last week showed similar findings:

And Barclayhedge reported a similar breakdown in a research piece published earlier this year (related post):

The bottom line is that performance fees, and to a lesser extent management fees, have never been as “standard” or inflexible as portrayed by some industry commentators.

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