COO Connect Editorial: Interview with Amy Bensted, head of the hedge fund team at Preqin
Hedge fund fees have been in steady decline since the aftermath of the financial crisis. Some investors now baulk at paying hedge funds the traditional 2% management and 20% performance fee. As things stand, the mean management fee charged by hedge funds is 1.60% while the performance fee is 18.93%. But is this trend about to change? COO Connect Editorial speaks to Amy Bensted, head of the hedge fund team at research firm Preqin about what the future holds for fee structures.
COO: Why are investors demanding fee concessions from hedge funds/funds of hedge funds?
Bensted: Historically, investors have felt that although fees were overinflated there was little they could do to improve the situation. Following the crash, institutional investors found that they had gained negotiating power with their fund managers – when asset raising became more difficult for fund managers, investors were in a position to request fee concessions as managers were in need of not only new capital but also really struggled to retain the capital they already had. Not only are investors increasingly asking managers to be flexible on the fees they charge, they are also looking much more carefully at the fee schedule. As institutional investors become more experienced in hedge fund investment, a manager can risk losing institutional backing as investors will reject the fund at the initial stages of due diligence as a result of an overinflated management fee. Preqin research indicates that 65% of all institutional investors have rejected a fund on the basis of “unjustifiable” fees over the past 12 months.
COO: Which types of investors are demanding fee concessions? Are some more likely than others?
Bensted: Investors across the board are requesting concessions from fund managers. However, it is the investors with the larger ticket sizes that are in reality the ones which are more likely to get the concessions they demand. For a fund manager, an investment from a large investor can make all the difference to their funds' future success in gaining traction in the institutional market, so by demonstrating flexibility to the largest investors in hedge funds (in terms of cash invested in their funds), they will increase the likelihood of future successful fund raising further down the line. Over the past few years many of the public pension funds (Calpers, Utah Retirement Systems) have been quite vocal in their demands for a change from the “2 and20” model – many public bodies are following this lead and looking more closely at the structures of hedge funds in the early stages of consideration of a strategy.
COO: For fund managers who are either emerging/seeded, are fee concessions fair and why?
Bensted: Investors are showing more interest in seeding funds and emerging managers continue to be popular among the more experienced segment of the institutional market. Investment in first time or emerging funds can offer many benefits to the institutional investor – being small and nimble can allow for sourcing better opportunities in the market, managers are often hungrier to produce returns and an institution may be among the earliest investor in a fund which could go on to be the next superstar performer. However, it is equally risky from an investor standpoint with no proven track record of the fund and a large proportion of emerging funds shutting before they reach critical mass. By providing seed or early stage capital to a fund manager, investors are taking on extra risk in their portfolios and fee concessions acknowledge this fact as well as making a vehicle more attractive to the investor looking at the emerging manager market.
COO: How should investors get the balance right between demanding fee concessions and ensuring the manager can operate his/her fund efficiently and without excessive cost cuts? Many institutional investors also expect high quality service providers and infrastructure from emerging funds, how do tough fee concessions impact this?
Bensted: Most investors are, in the main part, reasonable in their demands for change from 2 and 20. Institutional investors are becoming more experienced in looking at funds and are paying extremely close attention to how the firm is structured and works from an operational standpoint. Fees are certainly an issue for many institutional investors. However, fees overall rank relatively low on the scale of what they look for in a fund manager - coming 8th on the list of requirements after; strategy, track record/firm reputation, performance, risk management, liquidity, transparency and use of third party auditors. Therefore, investors are not requiring fees to be below a level which would negatively affect a managers’ ability to be able to fulfil these main duties. Investors just want fees to be set at a level which is reasonable and justifiable (i.e. to cover costs, not for profit) and at which both their needs and the interests of the fund management group are aligned.
COO: Do you see fees continuing to drop or is this just a temporary blip?
Bensted: I think management fees are going to begin to stabilise around the level they are currently and I don’t foresee a return to the traditional 2% management fee in the immediate future. Investors are in a whole much more satisfied with the level of fees being charged by the hedge fund industry than they were in 2008 – they can see that concessions have been made and that managers have worked at creating a sense of value for their clients. Performance fees are beginning to creep up towards the 20% mark and there may be more of a recovery on that front. On the whole investors are content to pay fees if the performance is there, and provided the performance fee schedule is structured appropriately - then by and large this will not come under much more pressure to change.