By Diane Harrison
The first quarter of 2013 is nearing its end, and the investment community will be mulling over a plethora of returns in various asset classes. Companies will be judged on their abilities to meet, beat, or fall short of earnings expectations. Investors will parse corporate earnings and other financial data to determine who’s ‘winning’ so far this year- the sector stars and the enviable opportunists who not only guessed right, but avoided overexposure, and therefore posted the highest-performing stats. Talking heads will fill the financial media screens explaining who wins, who loses, and why. Everyone will be measured against this first quarter yardstick, and, inevitably, hedge fund managers will find themselves hemming and hawing over criticism from investors about fees if returns don’t measure up. Some managers will be the hero, and some will be the goat.
Let us revisit the ‘hot button’ topic of fees—and do so in the context of earnings, with a twist. Rather than trumpet the media perspective so often touted, that of investor angst, let’s look at it from the side of the alternative managers earning their keep.
Fees, fees and more fees.
Amid all this competitive posturing, the pushback question will undoubtedly surface: “Why are your fees so high?” Managers feel the pressure from wary investors holding the asset cards to lower these costs. Fees in general are not the problem; rather, let’s re-focus on the oft-overlooked nomenclature that accompanies hedge fund returns: ‘net-of-all-fees.’ Four words that level the playing field amongst returns, but are often ignored in a rising tide of aggravation over funds performing under par. Hard-working hedge fund managers who actually do what they claim to do, which is beat their appropriate benchmarks, should stand up and be counted. Let those returns, net of all fees, speak to the value you bring.
If I could do this myself, I wouldn’t be hiring you.
It’s also time to reinforce the premise that alternative assets are meant to provide a means of obtaining performance above the levels obtainable through conventional, and generally less-risky, assets. To generate outperformance, a manager must either do only more of what’s positive, or mitigate the risky downside that often accompanies outsize returns. If downside risk counteracts upside gains, subpar performance results, which can include matching or marginally beating a benchmark. Managers who fall into this category will effectively be punished through redemptions or lack of new capital flows. If outperformance were easily achieved or obtainable from conventional investment sources, there would be a far smaller universe of alternative investment options, as investors would seek value within traditional sourcing.
You get what you pay for.
So the value proposition for investing in alternatives remains—to provide a means of obtaining performance different from other assets, which complements or enhances an investor’s overall investment goals. Investors have the ability to define this in many ways, with essentially each alternative investment providing a unique component to a portfolio. The premium in paying up for this type of investment category is mitigated by the convention of measuring alternative investments by their net returns. At the end of the day, it shouldn’t matter to the end user if an alternative manager charges twice as much as a traditional advisor when, net-net, the alternative manager delivers on the return objective.
Of course sub-performing alternative managers deserve and receive criticism for failing to achieve these objectives. Yet the investment community has begun, over the past tumultuous years, to throw the alternative baby out with the bathwater in a rising cry of outrage about funding shortfalls, liquidity concerns, and a host of other bothersome issues. But is it fair to saddle the successful alternative manager with the sins of his underperforming brethren?
Net-net, it’s the bottom line that counts.
The management and performance incentive fees charged by hedge funds now range more broadly than they did prior to 2008. There exists a 1 and 10 ‘value play’ for the most liquid and easily-traded strategies. There is a rising popularity of 1.5 and 20 for the majority of smaller managers looking to gain assets from disgruntled investors seeking to shift assets from their underperforming funds. The industry stalwart of 2 and 20 remains for established managers with a demonstrated performance record of beating their benchmarks. And, finally, there exists a pricey subset for an elite group of standouts who charge higher fees for superior abilities to achieve results.
Like life, hedge funds were not created equal.
To those critics who clamor for alternative fees to come down across the board, and ‘level the playing field’ for investors comparing alternative investment options, I submit that the hedge fund universe, like most things in life, is not a level playing field. It’s a meritocracy, where quality of performance counts. Managers shouldn’t be afraid to defend their value. Investors should expect to pay for performance returns above the benchmarks. The competitive reality in which both sides exist will ensure that managers worth their salt will succeed, and those that are exposed for not adding value will fade away. But the fees are not the issue; perception is clouding the reality of the process
Diane Harrison is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 and specializing in a wide range of writing services within the alternative assets sector. She has over 20 years’ of expertise in hedge fund marketing, investor relations, sales collateral, and a variety of thought leadership deliverables. A published author and speaker, Ms. Harrison’s work has appeared in many industry publications, both in print and on-line.