Hedge Fund Terms: Fees

The assault on hedge fund fees and terms continues, in no uncertain terms, making strides to further align manager and investor interests.

It is now rare to see a 2% management fee – the norm  is 1.5%, and that is prior to any additional negotiations related to lock-ups, amount of committed capital, AUM thresholds, and more.

When speaking with emerging managers, it seems that there has been an uptick in more ‘creative’ approaches to fund terms since January of this year. More and more we are seeing managers scale their management fee based on AUM, which allows them to further align their interests with the investor by negating the idea of asset gathering. For example, a fund manager may impose a 1.5% management fee on the first two hundred millions dollars; from $200-$500M the management fee would drop to 1.25%; and once past the $500M threshold, there would be a further drop to a 1% management fee.

Another add-on which has gained popularity among new launches, and which has been well received among investors, is a hurdle rate.  There are a few new approaches to this; for instance, the manager can use a peer group benchmark (i.e., HFRX) as a benchmark in the traditional sense (the manager only collects an incentive fee when outperforming the benchmark). However, (while not an entirely regularly-used practice), we have spoken with managers who will use their peer group as a benchmark, and will still collect an ‘outperformance’ fee if they outperform this benchmark, even if the fund is down for the said period. For example, if I am a L/S equity manager and am using the HFRX Equity Hedge as my benchmark, if the HFRX is down 10%, and my fund is only down 5%, I would collect a performance fee, even though there have not been profits in the fund.