Australian regulation could force managers to change their fee structures
Hedge funds marketing to Australian superannuation schemes could be forced to change their fee structures if they are to be compliant with the country’s proposed “Stronger Super” legislation.
Hedge fund fees could be impacted by Australian rules
One of the clauses contained in “Stronger Super” - “MySuper” – is aimed at reducing the number of high-fee investment products being marketed to Australia’s burgeoning superannuation fund industry. Hedge funds will be impacted as their performance fees will be required to meet five criteria *. If these criteria are not met, hedge funds cannot charge a performance fee.
“As things stand, most hedge funds will not meet the five criteria. If a superannuation fund agrees to a performance fee, the new draft provisions provide that the base ongoing management fee must be lower than it would be if there was no performance fee. However, most hedge funds do not offer fee terms which do not include performance. Nonetheless, I do not expect this will be a major hurdle,” said Peter Charteris, a partner specialising in superannuation at DLA Piper in Australia.
“Hedge funds should be able to address this requirement by also offering Australian superannuation funds a non-performance fee option. The ongoing management fee offered under the non-performance fee alternative can be at a sufficiently higher amount than that of the base fee in the performance fee option and would be attractive enough to the manager to consider without a performance fee,” he added.
The performance fee would also need to be measured against the performance of their peers in a bid to prevent managers charging incentive fees if they deliver poor returns. “The latest rules will certainly give superannuation schemes more clout when negotiating fees with hedge funds,” said Nikki Bentley, a partner specialising in investment funds at Henry Davis York, a law firm in Sydney.
However, there is a risk non-Australian investors could argue these fee concessions amount to a breach of the most favoured nation clause. “Hedge fund managers (will have) to be mindful of not tripping up most favoured nation clauses offered to non-Australian investors,” commented Charteris.
Nevertheless, most experts doubt the new rules will result in managers shunning the region's investor market. “I doubt the MySuper rules will have a major impact on hedge funds marketing in Australia. While there will be some more operational and administrative work for those superannuation funds that are covered by the rules to ensure compliance, not much will change for hedge funds. The Australian investor base is a considerable market for hedge funds and will not be ignored,” said Alex Wise, director at Orchard Harbour, an operational due diligence specialist in Sydney.
Stronger Super would also require superannuation trustees to consider whether their members are disadvantaged by the fund’s lack of scale. This, as well as the operational challenges the rules present, could lead to consolidation among the country’s superannuation funds. “These changes are likely to improve trustees’ bargaining power in relation to investment management fees because of the much larger mandates they are likely to be allocating, and in our opinion are likely to result in pressure building to reduce such asset-based fees in the future,” said Bentley.
This consolidation will further cement the trend among Australia’s investor base to continue allocating to the largest, brand name managers. “Australia’s large superannuation schemes will continue allocating to the large scale operators with economies of scale that can operate with reference to low fee arrangements. Australia’s largest superannuation schemes tend to allocate to the brand name hedge fund managers with large scale operations and infrastructure and you will never see these investors going for $50 million hedge funds,” highlighted Martin Jamieson, a partner specialising in fund management and hedge funds at DLA Piper in Australia.
Five Criteria hedge funds need to meet
1) If performance fees are paid, the amount of other fees must reflect a reduction to compensate for the performance entitlement
2) The period over which the fee is calculated must reflect the type of investment to which the fee relates
3) The performance of the investment must be measured by comparison with investments of a similar kind
4) The performance must be determined on a net-of-costs and, where possible, net-of-tax basis
5) The fee includes disincentives for poorly performing investments
Source - Henry Davis York