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Debate Escalates Over Hedge Fund Fees

Date: Tuesday, May 8, 2007
Author: The New York Times

Are hedge fund managers fees getting too rich for investors’ blood? While managers of these regulated investment pools are getting richer — they took home an estimated $14 billion last year — there are grumblings among some investors that their returns are not worth the fees.

Warren E. Buffet waded into the debate Sunday, saying at a press conference that because of the fee structure, investors are better off with low-cost index funds than with hedge funds.

“The gross performance may be reasonably decent, but the fees will eat up a significant percentage of the returns,” he said. “You’ll pay lots of fees to people who do well, and lots of fees to people who do not do so well.”

The best-paid hedge fund managers delivered returns of 30 percent and 40 percent last year, but the average hedge fund’s returns were decidedly more meager at roughly 13 percent, according to Hedge Fund Research, a performance tracker in Chicago.

And last year, hedge funds returned only slightly more than the average stock mutual fund, which gained 12.4 percent, but costs a lot less, according to data from Lipper, a unit of Reuters.

Furthermore, while institutions are increasing their holdings in hedge funds, the wealthiest Americans have been bailing out. According to the Spectrem Group, a consulting firm that specializes in retirement savings and investing by the affluent, 27 percent of the wealthy investors surveyed had money in hedge funds, down from 38 percent in 2005.

And the amount of money that wealthy investors — characterized in the study as those worth $25 million or more — had in hedge funds fell by an even greater percentage. The average balance, which was $2.8 million in 2005, was just $1.6 million last year, a 43 percent decline.

In most cases, managers do not deliver enough to justify their fees, Robert Discolo, head of hedge fund securities at AIG Global Investment Group, told BusinessWeek. “Most funds are doing things that can be replicated much cheaper.”

For their savvy and ability to produced big gains, hedge fund managers typically charge what’s known as the 2-and-20: 2 percent of the firm’s management fees and 20 percent of the firm’s performance fees, or a share of the profits. But to play with some of the big names in the hedge fund industry, investors are required to pony up more.

Renaissance Technologies‘ founder, James Simons, who topped Alpha magazine’s list of the top 25 hedge fund earners, charges 5 percent of assets under management and 44 percent of profits. Still, as The New York Times noted in an recent article, he trounces most of his competitors year after year. In 2006, the $6 billion Medallion fund posted gross returns of 84 percent; 44 percent after fees, explaining his $1.7 billion take.

BusinessWeek notes that some hedge fund are combating investors dissatisfaction with high fees by offering another share class: one that cuts costs for investors who commit to keeping their money in the fund for three years instead of the usual one-year lockup period. And some of the biggest institutional investors can also use their financial clout to muscle their way into special deals. Investors employ so-called side letters to negotiate everything from lower fees to increased disclosure on a fund’s holdings, according to the publication.

But it warns not to expect hedge funds to roll back fees en masse any time soon. With returns as high as 44 percent, top-performers like Mr. Simons don’t need to negotiate with investors.

“If you pay peanuts, you get monkeys,” Jim Dunn, a managing director with Wilshire Associates, an investment advisory firm, told The New York Times recently. “We don’t concern ourselves with fees. If you can provide Alpha, I’m less concerned about what you bring home.”