Annus horribilis for hedge funds illustrates benefits of performance-based fees
Sep 25th, 2008 | Filed under: Investment Management Fees, Today's PostCynics often describe the hedge funds not as a unique asset class or investment strategy, but as a unique “fee structure“. To some extent, they are correct. After all, mutual funds now use hedge fund strategies (long/short, 130/30 etc.) and yet we still call them mutual funds. Conversely, many hedge funds pursue high-beta long bias (a.k.a. mutual fund) strategies, yet we still refer to them as hedge funds. And indeed, one of the main regulatory differences between the two types of funds is the ability to charge a performance fee.
Hedge fund fees are generally viewed by the media with a jaundiced eye. Many people have expressed frustration that hedge fund fees don’t seem to budge - even as hedge funds have been producing lackluster absolute returns.
Take 2008 for example. A recent study by Eurekahedge recently found that 90% of hedge funds are currently below their hurdle rates or high water marks and are therefore at risk of earning no performance fee this year. And that was only as of July 31.
As Financial News reports:
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I tackled this a few weeks ago from another angle in my piece http://researchpuzzle.com/blog/2008/09/05/the-hedge-fund-dilemma/.
While I got at least one comment from a reader who believed that I was saying that all hedge fund managers and incentive fee structures are bad, that was not my point at all. I think that there should be experimentation and innovation in the area of fee structures, just as there should be in all aspects of this dynamic business. I find it hard to believe that the basic fee structure that is used by funds large and small — successful at adding real value and not — should be universally embraced, especially when there are open questions about the behaviors that are incented in a variety of environments.
Bravo! As many managers are merely asset gathers, with little to no performance concerns, just in business as a depository in order to gather the management fees, and depending upon typical investor inertia to withdraw.
Let’s applaud the hedge fund managers who at least try to earn excess Alpha for their investor clients.