Fee levels across traditional asset classes remained broadly stable in 2008. The same cannot be said about FoHFs. Even before the credit crunch took hold, a number of FoHFs started to lower their performance-based fees. The results are based on 39 searches conducted in 2008. For each search, we received a large number of responses on the fixed fees charged by asset managers. In the case of FoHFs, we also looked at performance-based fees. We highlight instances where large differences in deal size may have had an inordinate impact on our figures.

At first glance, the most expensive asset class in the survey seems to be FoHFs (126bps on average), followed by global property (124bps) and active currency (100bps). FoHF fees fell into a tight range of 124bps and 127bps compared to a range of 100bps and 135bps in 2007. We note here that FoHF deals in 2008 were considerably smaller in size: one was €20m; the other, €22.3m. In addition, a markedly different picture emerges when we take a closer look at FoHF performance-based fees.

Managers in 2008 cluster at lower end of performance-based fees

An analysis of two FoHF deals from 2008 shows 35 asset managers proposed charging a 10% performance-based fee. Another 20 said they would charge a 5% performance-based fee, the second highest in the group. Five said they would charge a 20% performance-based fee and only one a 24% performance-based fee, which represents the high end of the performance-based fee range. When comparing these results to a FoHF RFP from 2007, we see that as many as 6 managers proposed a 20% performance-based fee. In addition, two managers asked for a 23.92% performance-based fee while two asked for a 25% performance-based fee, the high end of the range. Unlike 2008, the 20% performance-based fee level comprised the second biggest group of managers in 2007. One conclusion we draw from this comparison is that demand for unconstrained strategies and FoHFs was stronger in 2007 than in 2008, allowing more asset managers to charge a higher level of performance-based fees.

The shift towards lower performance-based fees in 2008 is partly in response to one of the most tumultuous years for the hedge fund industry, one which saw investors withdrawing a record $152bn in capital in the fourth quarter, according to Hedge Fund Research (HFR). This capital outflow followed a record year of capital inflows in 2007, during which $194bn of new capital came into the industry. The subsequent dislocation and sustained volatility across financial markets is expected to further pull down FoHF performance-based fees in 2009 as investor risk aversion remains at historically extreme levels into the early months of 2009.

The survey does not include performance-based fees for other alpha-seeking mandates for which there was strong demand in 2007. There was markedly less demand for such mandates in 2008. Fees are typically higher in asset classes where managers have the most potential to outperform. The second most expensive mandate after FoHFs was global property (124bps). The most expensive asset category in equities was EAFE Small Caps (96bps), followed by emerging markets (82bps), which saw a 12bp drop compared to 2007.

Corporate bond fees

The lowest charged fees were in the fixed-income category, notably a European aggregate mandate (21bps) and a diversified global mandate (24bps). Investors were also drawn to corporate bonds as spreads reached historically wide levels in 2008. The average fee for a European corporate mandate was 27bps, while a corporate BBB portfolio had an average fee of 31bps. The European corporate mandates were relatively big: one was €650m, the other €300m. The table below will show a jump in the fee level of a convertible bond deal. The figures come with a caveat: the February 2008 fee is based on a €10m deal, while the 2007 example is based on a €100m mandate, making an apple-to-apple comparison difficult.

Last year saw most global equity markets fall by more than 40% in local currency terms, making it particularly difficult for active managers. The estimated number of hedge funds and fund-of-funds dropped for the first time since HFR began to collect data in 1990. The jury is still out on whether a combination of improving credit market conditions and an unprecedented level of global financial stimulus, will be supportive of industry performance, and by extension, fees. Corporate bonds are receiving newfound interest as potentially alpha generating assets. “If you look at the deal flow right now, we are conducting 15 searches at the same time and most are fixed-income mandates. Clients are now looking to invest more into high quality credit bonds,” says Simon Lai, Research & Development Analyst at bfinance.

Continued market turbulence insures that management fees will continue to be placed in greater focus than usual in 2009. This is particularly true for hedge funds where lower than expected performance could prompt asset managers to offer reduced performance-based fees as an incentive not to redeem. Funds that have offered returns above their benchmark are unlikely to come under pressure to reduce fees. An earlier bfinance survey showed a majority of respondents (60%) are disappointed with the fee they pay for actively-managed FoHFs. The survey covered 10 countries and 32 pension schemes, both corporate and sovereign.

 

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