A Call To Cut Hefty Hedge Fund Fees

Date: Thursday, May 3, 2012
Author: Halah Touryalai, Forbes

Here’s more evidence of a fundamental shift in the hedge fund industry: an influential pension consultant wants to see a big shake up in the way hedge funds charge investors.

Towers Watson, one of the world’s largest institutional consultants, is calling out hedge funds for what some see as an excessive performance fee of 20%.

Just like much of the rest of the financial services industry hedge funds have come under increased pressure by investors since the financial crisis in 2008. Investors have re-evaluated the value hedge funds actually add to their investment plan, and as a result have greater negotiating power, a Towers Watson report says.

Hedge funds typically have a 2 and 20 fee structure. The initial 2% is a management fee charged off the bat to cover the costs of operating the fund. Though some might argue that 2% does more than cover just operations. But it’s the 20% performance fee that is being questioned by Towers.

That 20% is what the fund manager takes from any profit made that year net of management fees. Towers says that kind of fee structure isn’t very fair to the investor who’s put all his capital at risk. The interests of the manager and investor are not totally aligned in that structure because while managers share in the profit they don’t share losses so “there is an incentive to take excessive risk rather than targeting high long-term return.”

“Hedge fund managers should be compensated for their skill (alpha) and not for delivering market returns (beta.),” Towers notes in its report titled Hedge Fund investing – opportunities and challenges.

Towers suggests that only one-third of alpha should go to the hedge fund manager.

The hedge fund industry had a pretty dismal year in 2011 with disappointing returns and regulatory crackdowns. Yesterday Nathan Vardi reported that the latest hedge fund titan to stumble is Man Group, the world’s largest publicly-traded hedge fund firm. Notes Vardi, “The $59 billion hedge fund started the month of May by announcing that in the first quarter of 2012 investors in Man’s hedge funds withdrew $4.1 billion, which netted out to $1 billion of outflows.”