Innovative new fee structures cast doubt on the dominance of "2 & 20"

Date: Thursday, December 20, 2012
Author: Parin Shah, ProHedge.co.uk

Hedge fund managers are increasingly looking to flexible and tailored fee structures to improve the alignment of investor and manager interests and help ensure a stable capital base. This is according to a new whitepaper published by law firm Hirschler Fleisher, which claims to have seen such trends manifest through investor “side letters” written on the part of new launches and emerging funds in particular.

Sliding scales fees pegged to assets under management (AUM), 2-3 year periods for performance measurement and benchmarked hurdle rates over a multi-year lock-up period are just some of the more dynamic fee structures seen. As HedgeCo.net reports this is not a case of blanket discounting away from the dominant “2 & 20” model, more a case of funds finding ways to incentivise long term investor commitment.

Managers should take care when employing new fee structures. Founder share classes, for example, do not guarantee that aggressive investors will no choose to seek additional side letter concessions. Furthermore investors have been seen to negotiate highly favourable agreements for follow-on capital and the gains on investment, not just initial capital invested. To overcome such issues to some extent, managers have often turned to offering equity in the management company; in this case it is important to ensure that equity stakes can be trimmed down as AUM increases to avoid large investor windfalls.

In an era where hedge funds are being selected on the basis of the investor mandate, the “2 & 20” model is looking increasingly archaic. Tailored fee structures, when applied with due consideration, can help convince investors to ride out the future with a fund over the long term.