THE REMARKABLE RESILIENCE OF HEDGE FUND FEES
Hedge fund fees have proven remarkably resilient since the financial crisis. Although they have come down from the 2/20 mark, according to the 2016 Preqin Global Hedge Fund Report, the average management fee for a single-manager hedge fund in 2015 was still 1.58%. This was a move in the wrong direction compared to 2014 when average management fees were 1.55%. That might not sound like much of a difference, but it is the biggest year-on-year increase in single-manager management fees since 2008. Preqin’s data also shows 35% of single-manager funds still charge 2% while 3% of funds charge more than 2% (an increase of 1% since 2014). The average performance fee meanwhile, was 19.4% in 2015.
Hedge funds have come under considerable pressure to cut their fees and some investors, including CalPERS, have decided to drop their hedge fund allocations driven in no small part by the high fees levied on returns.
Bob Maynard, chief investment officer at the Public Employee Retirement System of Idaho (PERSI) points to high fees, asymmetric rewards and lack of transparency as three of many concerns about hedge funds. ]
“I am not a fan,” he says. “We don’t do hedge funds, and have no plans to look at them in the foreseeable future.”
Considered in the context of their performance, it is perhaps surprising fees haven’t come down further. They have, in fact, proven to be remarkably resilient, especially as they are actually starting to edge back up. Maynard points to the “abject failure of their claims in the mid-2000s”.
Hedge funds had been promising good returns with a low standard deviation – equity-like returns for bond-like risk in other words. But, investors’ experience has been less than bond returns with equity-like risk. Hedge funds also claimed to offer better and safer returns in tough times through absolute returns. However, between 2007 and 2009 hedge funds had big negative returns. Maynard’s figures show returns of around -19% for the full year 2009, which was considerably worse than the standard 60/40 conventional portfolio construction, which lost around 16% on the same basis.
Hedge funds also claimed they were a good diversifier, offering low correlations with other asset classes.
“Their returns have been more cash-like – pretty close to zero overall,” Maynard argues. “Burying your money in the backyard would have given the same low correlations.”
In the context of a 60/40 portfolio construction, their basic impact has been akin to shorting the S&P 500 and putting the money in cash or other asset types. “Most portfolios do underweight the S&P 500 and put the money elsewhere,” Maynard continues, pointing to institutional investors’ allocations to real estate, private equity, emerging markets etc.
“So, bond-like returns with equity-like volatility, poor returns in tough times, and a poor diversifier to actions usually taken in standard portfolio construction,” Maynard sums up. “Add high fees, lack of transparency, headline risk (Amaranth etc) and what’s not to love?”
