Top hedge fund executives stand firm on fees

Date: Thursday, December 17, 2009
Author: Laurence Fletcher, Reuters

Top hedge fund executive are digging in their heels on fees, convinced that the industry's lucrative "2 and 20" charging structure will survive client pressure after the credit crisis.

Speaking in a series of exclusive interviews, Man Group (EMG.L) chief executive Peter Clarke, GLG (GLG.N) senior managing director Pierre Lagrange, Winton Capital managing director David Harding and CQS head Michael Hintze highlighted the growing confidence of a sector laid low last year.

They believe any funds which can deliver returns for clients will be able to persevere with a flat annual charge of 2 percent on assets and 20 percent on excess performance, a model which has endured since the early days of the industry.

"You'll always be able to charge 2 and 20, or whatever you want, if you can demonstrate performance," said Harding, who also founded managed futures firm Winton Capital Management.

High fees have earned some of the top hedge fund performers huge pay days. John Paulson's bets on the subprime meltdown made him $3.7 billion (2.3 billion pounds) in 2007, according to Alpha Magazine.

But pay has been expected to come under pressure after returns went south for many funds during the crisis, and investors headed for the exit.

Clients withdrew $330 billion over the 12 months to June, according to Hedge Fund Research, while funds saw performance losses of around 19 percent in 2008, leading to predictions of a wave of cuts in the battle for business.

"There is pressure on fees but I don't see fees falling automatically," said GLG's Lagrange.

"Clients want to be sure about what they get for 2 and 20. There will be a polarisation of players, between those that meet the infrastructure demands and deliver on performance -- they will be able to keep fees -- and those that don't."

Before a widespread market rally took hold, some 30 percent of hedge funds in a survey by Lipper at the beginning of the year anticipated a cut in management fees, while about 15 percent saw pressure on performance fees.

MARGIN SQUEEZE

It should be no surprise hedge funds are determined to keep the 2-and-20 model, as investors clamour for more checks to avoid a repeat of Bernard Madoff's $65 billion fraud, with costs to comply with regulation likely to rise.

Small firms could face costs of up to 100,000 pounds to comply with proposed European Union hedge fund laws, according to IMS Consulting.

And initial costs for the combined hedge fund and private equity sectors could be between 1.3 billion euros and 1.9 billion euros, said the Open Europe think tank.

"I think margins will be squeezed by costs rather than by fees," said Clarke, whose firm runs $44 billion in assets.

"Short-term this may reduce profitability ... if you (go) onshore, costs could be significantly higher."

Clarke believes that while big firms benefit from their resources and small managers can play niche strategies and trades to deliver returns, mid-sized firms could struggle.

"There will be a polarisation, with the big, the small, and not so many in the middle," he said.

"New start-ups will find it difficult," said CQS's Hintze, who set up the company in 1999. "The days when you can start with $25 million have gone."

After a 2008 in which many funds denied investors access to their money, angering some clients, Lagrange believes the industry has to learn from its mistakes.

"The industry ... has to do a mea culpa on side pockets, suspensions and all these things -- mistakes that happened," he said.

"In most cases it was right to do it at the time but clients hated it and you want to make sure you don't do it again."

While executives agree the industry can get back up to its peak level of $2.7 trillion in time -- Man Group's Clarke estimates three to five years -- the outlook is tough for parts of the industry, and profits could be hit.

Prime brokers are giving funds more leverage -- the UK's FSA estimates leverage crept up to 1.2 times between October 2008 and April 2009, while brokers say it has since risen to 1.4 times -- but funds may never again have access to the credit they once enjoyed.

"The chances of leverage coming back to levels the industry saw in 2007 are very, very small," said CQS's Hintze.

"Leverage will pick up again, but investors will be much more demanding about infrastructure, whether you're leveraging the right instruments, for example, and banks will insist you put down more collateral."