Of course, averages are not something that work in the hedge fund world. Nobody sets out to select an average hedge fund manager. Aon Hewitt principal, Matthew Towsey, says: “The average hedge fund is not good value. The returns are not compelling and that is not what investors should be aiming for.”
HOW HAVE HIGH FEES PREVAILED?
“Some hedge funds are good value,” Towsey continues, “but it depends what the investor wants. If a hedge fund is generating alpha – returns that are uncorrelated to markets and are unique – then that is a highly-prized commodity and investors should be willing to pay for that.”
Investors can indeed hit a home run if they are able to pick a top performing hedge fund. The top decile outperformance by hedge funds far exceeds that of the top decile of public equity managers. But picking those managers before they embark on a strong run (when fees are also more negotiable) is no easy task and requires a skill level few possess.
“Some may have the skill to pick in advance,” Maynard says, “but I’m not about to bet any of our money on us having that skill.”
IS THE SELECTION PROCESS BROKEN?
The selection process plays no small part in hedge funds’ ability to maintain high fee structures.
Not least, the temptation to fire underperforming managers and hire those who are outperforming directly undermines investors’ capability to negotiate on fees. A manager producing strong returns is much more likely to have more demand from investors and can therefore more easily set higher fees. Yet, evidence has repeatedly shown managers who have performed very well are less likely to continue doing so and vice versa.
The preference among both investors and consultants for larger, big-brand hedge fund houses is another weakness in investors’ ability to drive down fees. “Those funds, if they have performed well, and are close to capacity, continue to ask for high fees,” Towsey says. “Some of them have not responded to the pressure to reduce fees as they are still able to attract assets.”
Amy Bensted, head of hedge fund products at Preqin, says: “There are still a lot of funds out there that haven’t changed their fees; a lot of the largest funds are able to command higher fees due to interest in their strategy and some are able to justify it through performance.”
Only where blue-chip hedge funds have struggled to perform and consequently seen outflows, have they responded on the fee front. This underlines the problems associated with hiring outperformers.
Furthermore, large funds, which are now often managing assets well into the billions, are still charging high management fees. As Beachhead’s Beer points out, a 2% management fee on a $10m fund covers rent and overheads, but once that fund reaches $10bn a 2% management fee raises $200m for the firm, a large proportion of which is pure revenue.
