The financial crisis of 2008 prompted nearly half of the hedge fund managers in our first annual fee survey to anticipate a change in their fee structure. Yet hedge fund executives are now digging in their heels and performing u-turns following the widespread market rally. Our new survey results, which come a year after the financial crisis and ten months since the rally took hold, show that the overwhelming majority of single hedge fund managers now believe that the industry’s 1.5-2% base fee and 20% performance fee structure will survive downward client pressure.

A wide group of hedge funds were asked to respond yes or no to the following question: will single hedge fund managers maintain their 1.5%-2% base fee and 20% performance fee structure in 2010? Eighty-eight percent of hedge funds say they will not lower fees compared to only 56% a year ago. Of the minority 12% who do anticipate lower fees compared to 44% last year, the average base fee forecast is 1.3%, while the average performance fee forecast is 14.8%.

This year’s results indicate that hedge funds and FoHFs will be able to persevere with a flat annual charge of 1.5-2% on assets under management and 20% on excess performance, a model which has endured since the early days of the industry. Sixty years after Alfred Winslow introduced the concept of a performance fee structured as a function of realised profits, with a set management fee to offset operating costs, the concept of two-and-twenty is still very much intact. This has been widely open to debate during the financial crisis when returns dropped for many hedge funds and investors headed for the exits.

Research for the alternative manager fee survey, which is the second in our series, was conducted in December and January 2010. Our questions were sent to 28 single manager hedge funds and 68 FoHFs with a total of €674bn in AUM. Twenty-seven percent of the hedge funds, the largest group among the respondents, have more than €5bn in AUM while 23% have between €2-5bn. Thirty-three percent of the funds are domiciled in the Cayman Islands, 32% have multiple locations, 8% are domiciled in Luxemburg, 6% in the US, 4% in France, 4% in Canada, 4% in Ireland, 4% in Guernsey, 3% in Bermuda, 1% in UK and 1% in Finland.  However, just 1% of the portfolio managers are actually based in the Cayman, with 28% in the US and 24% in the UK, 15% in multiple locations, 6% in France, 6% in Canada, 6% in Switzerland, with the rest scattered across 12 other countries.

The chart below shows how median fees for underlying single hedge funds have remained more or less stable this year compared to December 2008. Underlying hedge fund managers demand the highest base fees in general with 32% reporting base fees in the 150-200bps range, which has changed little compared to the results of our previous survey in December 2008. Passive strategies have gotten cheaper with 35% of FoHFs charging a base fee of 50bps or less for a $100m investment compared to 27% in December 2008.

Base fees are somewhat lower for FoHFs

Graphs comparing hedge fund fees (click here)

With markets on the rebound, fewer in the hedge fund industry believe base and performance fees will come down compared to our first survey. Asked if FoHF base fees will go down, increase or remain unchanged in the next six months, 51% believe they will remain unchanged and 49% say they will go down. Last year, a larger percentage (54%) thought base would drop and 46% expected base fees to stay the same. The same trend can be observed concerning FoHF performance fees: only 38% anticipate performance fees to drop in the coming six months, 8% lower than in our first survey. Another 61% believe performance fees will remain unchanged, 11% higher than in our last survey. An even smaller percentage (38%) believe underlying hedge fund base fees will drop while 62% say they will remain unchanged in the coming six months.

The results reflect the reality that hedge funds have recouped the entirety of their 2008 losses and that the industry is confident investors will pay the price for their performance. Even as investors try to lower the fee structures of their asset managers (see our pension fund fee survey), hedge fund managers are not prepared to do so in the near future. One of the reasons for this is that hedge fund fees respond immediately to performance. Hedge funds gained 18.5-20% in 2009 depending on the index-tracking firm, making it the industry’s best year since 1999, when they returned 31%. The reversal in their fortunes has led to the drying up of concessions some hedge funds had offered in the thick of the financial crisis. 

Fewer believe base and performance fees for FoHFs will decrease (click here)

Fewer believe base and performance fees for hedge funds will drop (click here)

The second section of our hedge fund fee survey focuses on liquidity issues and some of the concessions hedge funds are prepared to make in exchange for redemption restrictions. Asked if hedge funds would consider offering a fee discount to an investor in exchange for a one-year lock up, only 29% say they are willing to do so, compared to 46% in our first survey. The overwhelming majority (71%) are unwilling to consider a fee discount in exchange for a one-year lock up. The picture improves as the lock up period extends. A majority (60%) are prepared to offer a fee discount for a two-year lock up and 71% for a three-year lock up. As the chart below shows, the percentage of managers willing to offer a fee discount was higher a year ago for all lock up periods. We also asked single hedge funds if they would accept adding hurdle rates in exchange for a longer lock up. Only 19% are willing to do so.

Graphs comparing manager willingness to offer discounts for lock ups (click here)

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