Fee pressures on start-up hedge funds cause for concern, says Seward & Kissel
Start-up hedge funds are increasingly feeling the pinch as institutional investors demand more fee concessions, according to findings by law firm Seward & Kissel.
While performance fees among start-ups remain pegged at 20%, there is greater dispersion for the traditional 2% management fee. A majority continue to charge 2% although 26% charge 1.5% while 13% receive 1%. “About 40% of the funds offered lower incentive allocation/management fee structures for investors who agreed to greater than one year lockups typically represented by different fund series, classes or sub-classes,” said the report.
Research in 2011 by Preqin said the average hedge fund management fee stands at 1.6% while performance fees are at 19.2%. Figures coming out of Hedge Fund Research (HFR) paint an even more depressing picture for managers. Hedge Fund Research said new managers by and large charged a 1.58% management fee and a 17.04% performance fee over 2011 – the lowest figures since 2003.
“Post-2008 when hedge funds suffered poor performance, investors felt that fees were too high. A lot of larger hedge funds, according to some investors, were making most of their money off the 2% management fee, which meant performance was not top of the agenda. This is why we are seeing investors pressuring managers on fees,” said Steven Nadel, partner at Seward & Kissel.
However, there are concerns that some investors are pushing down management fees to unworkable levels. Managers, particularly start-ups, have to satisfy investors with institutional-standard infrastructure and operations. Furthermore, hedge funds are being hit by a deluge of regulation coming out of the US and European Union.
“A lot of hedge funds launching are not multi-billion dollar shops but closer to $50 million and $100 million in Assets under Management (AuM). Reducing fees does expose managers to pressures although it does depend on the strategy the manager employs. If they have a complex strategy which requires manpower and technology, then fee pressures can be an issue. Regulation is also increasing the cost base as managers with more than $150 million will need to register with the Securities and Exchange Commission (SEC) and submit a detailed Form PF. I doubt a 1% management fee would cover that unless a manager is incredibly lean,” commented Nadel.
The findings also revealed that approximately 50% of hedge funds launched in 2011 adopted an equity or equity-related strategy. About 1/3 of those strategies were focused on US equity, while ¼ were sector-specific with financial services and healthcare being the most popular. Some 20% of launches were multi-strategy while 10% specialised in credit.
Hedge Fund Research data revealed equity strategies were down on average 5% in 2011 although they are up 3.78% year-to-date (YTD) 2012. “I did not expect to see so many equity focused launches given the turbulent markets. Personally I anticipated more credit-focused or structured product hedge funds to come into the fold,” said Nadel.
The survey also said most managers (80%) preferred a master-feeder structure and continued to domicile in Cayman Islands. However, “there were a fair number of managers who initially launched just a US standalone fund, many of whom were seeking to build a track record in order to attract offshore and US tax exempt investor interest down the road.”