Investors warned against fee pressure on early-stage managers
Institutional investors must not exert downward pressure on hedge fund fees if it compromises the quality of operational infrastructure at those businesses.
“Our main concern is that managers are able to operate within the fees they charge. It is essential hedge funds have sufficient operational infrastructure in place and investors must be careful they do not exert excessive pressure on fees if this compromises the operational infrastructure at managers,” said Tushar Patel, managing director and chief investment officer at Hedge Fund Investment Management (HFIM), a London-based firm focused on emerging managers.
There has been downward pressure from institutional investors on hedge fund fees – the traditional 2% management fee and 20% performance fee – since the financial crisis. A survey conducted by J.P. Morgan’s Capital Introductions Group in 2013 said 70% of investors expected fees at hedge funds to decline. “We sometimes hear of institutional investors pushing for managers to charge 1% and 10% or 1% and 15%. We have tended in the past not to negotiate aggressively on fees on firms that have small assets under management or are emerging,” said Patel.
This pressure on fees comes as hedge funds face ever mounting costs courtesy of global regulations and demands from institutional clients that they enhance their operational infrastructure. Citi Prime Finance’s 2013 Business Expense Benchmark survey found fund managers needed at least $300 million in assets to enable their management fee to cover their operating costs and regulatory requirements.
Firms with less than $300 million will struggle to pay for management company costs such as third party expenses, salaries and compensation without additional capital or incentive fee pay-outs. In Citi’s 2012 survey, it estimated hedge fund managers running under $250 million spent approximately 198 basis points of their 2% management fee on operations and third party service providers alone.
This increased expenditure is mainly attributable to the onslaught of global regulations on both sides of the Atlantic. Under Dodd-Frank, hedge fund managers must supply the Securities and Exchange Commission (SEC) with the highly-forensic Form PF document, and the Commodity Futures Trading Commission (CFTC) with a Form CPO-PQR. Meanwhile, in the EU, managers are facing the Alternative Investment Fund Managers Directive (AIFMD), a regulatory initiative which BNY Mellon calculates could cost the average hedge fund manager anywhere between $300,000 and $1 million.
Excessive investor pressure on fees could therefore make running a start-up business unsustainable.
However, others point out fees have remained stable despite several years of disappointing returns. A survey of investors by the capital introductions arm of Goldman Sachs Prime Services found the average management fee to be 1.6% and the average performance fee to be 18.1% in 2013, a marginal drop from 2012. A survey of clients by law firm Seward & Kissel reached a similar conclusion, finding management fees stuck around 1.6% while performance fees continue to be pegged at 20%.