Mixed picture emerges on hedge fund fee structures

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Hedge fund industry fee structures continue to evolve

Average hedge fund management fees have increased due to increased regulatory compliance and pressure from institutional investors to maintain more robust operational risk management.

Management fees have increased to an average 1.58% after 2007. In 2002 the average management fee was around 1.38%, according to a study by eVestment.

On the other hand fund of hedge funds (FoHF) management fees have decreased from 1.32% before the crisis to 1.26% after 2007. The current trend looks set to continue for some time but may be pressured as underlying funds raise their management fees.

In contrast performance fees show an inverse relationship to changes in management fees, says the study. Average performance fees were 19.82% for hedge funds launching before 2002. During 2002-07 this fell to an average of 19.58% and after 2007 they fell to 19.25%.

Price competition among hedge funds on incentive fees is thought to be one of the reasons for the fall.

On a strategy basis, however, the changes in fee structure are more varied. All hedge fund strategies with the exception of managed futures have seen different degrees of rising management fees. Movement in incentive fees was mixed across both strategies and time.

Credit strategies have experienced a sharp drop in the most recent period in average management and performance fees. Distressed and securitised credit funds have seen rises in both average fees since 2007.

Although the number of new distressed funds was relatively low over the period considered, growing investor interest, a willingness to allocate to niche and illiquid strategies plus market conditions after the financial crisis may have benefited these strategies, according to the study.

Equity strategies, including event driven, special situations, long/short equity and non-directional equity, have hardly changed over the time period. Macro and managed futures launched since 2007 offered smaller fees, something eVestment believes is unexpected given this strategy's outperformance in 2008 and 2009.

As a whole, however, the hedge fund industry continues to favour the two-and-20 fee structure. This accounts for around a third of all funds. The 1.5% and 20% structure represents almost a quarter of the industry's active hedge funds. Variation is most common in management fees, with more than 80% of hedge funds offering an incentive fee of 20%.

FoHFs, however, have raised incentive fees from 11.13% before 2002 to an average 12.73% since 2007. This results may be misleading, cautions eVestment. Formal studies and anecdotal evidence suggests an increase in the willingness of FoHFs to produce bespoke solutions and negotiable fee structures for clients. "We posit the emergence of a two-tiered client base for FoHF firms with the bifurcation caused by larger allocators' supplier power and FoHF firms' attempt to maintain margins," writes eVestment.

Institutional investors continue to demand flexible fee structures and generally do not reflect the average fees of commingled FoHF products, according to the study. Smaller investors have benefited from increased competition among FoHFs on the management fee side but have only contributed indirectly via higher incentive fees to the marginal dollar offset for the increased infrastructure costs of FoHFs' bespoke services, concludes the study.

eVestment concludes the fees charged by hedge funds and FoHFs will continue to be a much-debated topic. While the structures are receptive to change, there is impetus for further evolution, including the realisation of alternative strategies from the encroachment of mutual funds into alternatives and hedge fund platforms and wrappers plus increasing geographic diversity.

The study looked at historical trends in fee structures based on product inception. eVestment used three timeframes separated by periods of high industry churn: pre-2002, 2002-07 and post-2007. eVestment's commercial dataset includes currently active and liquidated funds, covering 23,000 products.news-evest1-0813

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