Hedge funds cut incentive fees

Date: Tuesday, September 29, 2009
Author: Shirley Won, Globe and Mail

Performance fees are the lifeblood of the hedge fund industry, but last year's stock market tsunami is changing the way some Canadian players do business this year, or forever.

Front Street Capital Corp., Northern Rivers Capital Management Inc., Goodwood Inc. and Goodman & Co. Investment Counsel Ltd. are among firms that are waiving or offering some relief on incentive fees after some of their funds lost big money last year.

Front Street Capital will not charge performance fees this year on almost all the current assets in its flagship Front Street Canadian Hedge Fund run by manager Frank Mersch, and Front Street Canadian Energy (formerly Front Street Mining Opportunities) run by Normand Lamarche.

"The fees are waived for at least 2009," said Chris Fontana, director of sales at Front Street Capital. "It was a rough ride [last year], and we recognize the volatility ... It's the right thing to do."

The two funds have been rebounding this year after losses ranging from 40 to 68 per cent, but it's still off a low base, Mr. Fontana noted.

While there are different wrinkles to the fees charged by hedge funds, most formulas include a 2-per-cent management fee and a 20-per-cent performance bonus. Some funds might not charge a bonus until it reaches its high-water mark - the highest net asset value (NAV) of the fund. That benchmark can be reset over short periods, such as annually or every two years, depending on the investment. The definition of high-water mark also varies.

Under the offering memorandum for the two Front Street funds, they would be eligible for a performance bonus this year. It kicks in if they earn above 6 per cent after fees. Front Street Canadian Energy has already gained more than 130 per cent so far this year.

Fund analyst Dan Hallett gives kudos to managers willing to share some of last year's pain with investors. "It certainly goes a long way to either building good will, or in some cases rebuilding good will, with investors by giving up the performance fee," he said.

Northern Rivers Capital Management has slashed its performance fee by half on its flagship Northern Rivers Innovation LP, on which it has also temporarily suspended redemptions. "In view of the fact that last year was such a difficult year, we didn't feel comfortable taking the full amount that we were entitled to take," said Robyn Graham, vice-president of sales and marketing at Northern Rivers.

The Northern Rivers Innovation fund and its RRSP version were eligible for a performance fee if they earned more than 2 per cent per quarter because its high-water mark is reset annually, too. Northern Rivers did not consider waiving the fee entirely because the funds earn only a 1-per-cent management fee, which is "half of what the industry charges," Ms. Graham said. "It is the total fee structure that is important - not only the performance fees."

For example, Northern Rivers Innovation LP, which lost 66 per cent last year, posted a 29.4-per-cent gain in the second quarter, but will take only a 10-per-cent fee above 2 per cent. "We intend to maintain this lower rate until the fund regains its all-time high-water mark achieved in April, 2007," Ms. Graham said.

Goodwood Inc. has also cut some slack for investors in its Goodwood funds. While the two hedge funds can reset the high-water mark every two years, and could do so this calendar year, it has suspended this right. "We are foregoing any claim to future performance fees until we have surpassed the Jan. 1, 2007, valuation level," said Goodwood chief executive officer Cameron MacDonald.

Goodman and Co. Investment Counsel Ltd. is providing some retroactive relief from performance fees by instituting high-water marks for its Dynamic Power Hedge and Dynamic Power Emerging Markets funds, both of which lost more than 70 per cent last year. The changes, which came into effect mid-year, created two groups of investors for the purpose of calculating performance fees.

Investors who bought either of the funds in 2008 or earlier benefit from the decision to waive future performance fees until the funds' NAV are higher than at the end of 2007. For investors who bought units this year, the high-water mark is the NAV at the end of 2008.

David Goodman, CEO of DundeeWealth Inc. which owns Goodman and the Dynamic fund family, opted to institute high-water marks rather than temporarily waive fees for this year because that was in the better interest of investors. "If we don't reach our high-water mark, we won't charge you a performance fee," he said. "That is good forever."

Salida Capital Corp., whose Salida Multi-Strategy Hedge fund lost 67 per cent last year, has no plans to change its fee structure. The fund earns a bonus if it can beat the best return of the past 12 months of performance.

"Our fund, since inception until the end of August, has compounded annually at 25.7 per cent, while the TSX is up 4.3 per cent," said Salida CEO Courtenay Wolfe. "Our plan is to exceed the returns of other investment opportunities [over the mid to long term]. If we continue to do that net of fees, the fee structure should not be an issue."

*****

Paying for performance