The income hedge funds receive from performance fees has fallen drastically this year, dropping more in the first half of 2015 than in the previous seven years combined.
The fear is the drop in performance fees, coupled with weak returns across the hedge fund industry, could force both new and established funds into closure.
According to Eurekahedge, the data provider, new hedge funds are charging average performance fees of 14.7 per cent, a sharp drop on the 17.1 per cent typically charged in 2014.
Several high-profile hedge funds, including Fortress’s $2bn macro fund and Renaissance Technology’s $1bn computer-driven fund, have already been wound down this year after delivering poor returns to investors.
Jean Keller, chief executive of Argos, the Swiss hedge fund company, said: “The firms that cannot generate returns and demonstrate true investment talent will disappear. The fact that, overall, the industry has not delivered this year and more generally since 2008 will be an enormous challenge.”
Preqin, the data provider, last week predicted this would be the worst year for performance across the hedge fund industry since 2011 as managers struggle to respond to uncertainty over Chinese monetary policy and US interest rate rises.
Mohammad Hassan, senior analyst at Eurekahedge, said: “With increasing competition in the industry, regulatory costs and the current market uncertainty, lower fees could lead to an early demise for otherwise good hedge fund investment models.
“If things deteriorate then you could see closures spike over the next year. Smaller funds will be more at risk, given their business model places a larger reliance on performance fees.”
The drop in performance fees has been sharpest among the popular long/short equity category of hedge funds, according Eurekahedge.
The data provider added that the emergence of mainstream funds offering hedge fund-like strategies has contributed to the decline in performance fees, which have hovered between 17 and 18 per cent since 2009, after falling from 18.8 per cent in 2007.
Troy Gayeski, a partner at SkyBridge, the US fund of hedge funds company, expects more fee reductions in light of weak returns across the industry this year.
“2011 was the watershed year when high-quality managers in attractive strategies began to offer meaningful fee discounts. The trend to lower fees has been firmly in place since then, but this year’s performance will further accelerate that trend,” he said.
Fixed management fees have climbed over the past four years, from 1.6 per cent in 2011 to 1.7 per cent today, but that only matches the average management fee level in 2007.
David Walker, director of European institutional research at Cerulli Associates, the research firm, agreed that smaller hedge funds are particularly at risk.
He said: “A 2.5 per cent average loss by mid-October means many managers will be relying on their [management] fee to finance their operations and pay their staff. This will be painful for smaller hedge funds whose assets alone struggle to generate significant fees.”
However, Michaël Malquarti, co-fund manager at Altin, the Anglo-Swiss fund of hedge funds company, welcomed the reduction in fees. “Launching a hedge fund is always a risky business and will always remain so. It might just be a bit tougher to get rich very quickly, which is not a bad thing.”
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The confidence game of the hedge funds is a bad deal at any price.
Reminder: the big move is not only on the fees but on the client base. E.g
http://www.bloomberg.com/news/articles/2014-09-15/calpers-to-exit-hedge-funds-citing-expenses-complexity
“With increasing competition in the industry, regulatory costs and the current market uncertainty, lower fees could lead to an early demise for otherwise good hedge fund investment models."
I assume this was not meant to be ironic. But I'm afraid it rather makes the opposite point to the one intended by its author.....
Much of the advantage that hedge funds and private equity enjoy comes from various tax avoidance and tax arbitrage strategies. These are still available but are gradually coming under pressure from wider changes in society ( George Osbourne's disgraceful fudge on allowing CGT on carry for UK PE houses simply can't stick for long). As these decline you have to make money from returns based on much more difficult strategies, such as guessing which way interest rates or currencies will go or in trades that are already proven but are well known and crowded out to zero returns.
The only time to pay for performance is when you are convinced it is genuine, i.e. after many years, and where the manager personally loses his own money if the fund does badly.
And then consider what's available from Vanguard on an ultra-low cost basis. This exposes the con trick, or at least the wishful thinking all round, that nicely describes most active management.
And don't raise the "price formation" argument. The only people who make that argument are interested in short term trading rather than long term investment.
Wouldn't it be nice if the cost of housing in London fell a bit as a result of less fund management fees flowing around.....
@HopeSprings Ultra-low cost funds are mostly ETFs so minimal fuss is needed to run them.
I recently received a note from one of my GPs announcing that performance fees would be raised from 20 to 25%. Management fees would remain unchanged at 2%. He explained that it would be impossible for his business to operate otherwise. It almost sounded like his children would starve.
When my investment committee meets at the end of the month, I will make the case for a 100% redemption in our existing LP interest.
@Emkay thanks for this comment - if you can discuss further please email me (madison.marriage@ft.com)
These poor fellas, this is a tragedy. . What will happen to the international art market, and the market for yachts if these humanitarians aren't able to secure their 2 and 20's? These investors ought to be ashamed of themselves pushing on fee structures.
I do not pay management fees. I have no problems with just an incentive fee.