Of performance fees and other such things
So according to the Financial Times, hedge funds can no longer be defined by their “2 and 20″ fee structure… apparently, due to popular demand/pressure from investors, most hedge funds have opted to lower their fees, with the average management fee in 2009 being 1.65 and the median being 1.5 according to alternatives information provider Prequin. In fact, only 38% of funds report adhering to the traditional fee structure. The Financial Times also reports that in addition to changing their fees officially, many funds are open to making negotiations of special terms with investors.
The article points out several problems with existing performance fee structures: namely misalignment of client and management interests. Two things put in place to try to remedy this misalignment are hurdle rates and high water marks.
Hurdle rates (where only returns above a target rate count for the performance fee) and high water marks (whereby funds that have given up performance have to regain their previous highs before performance fees can be charged again) have become mainstream, but they are not sufficient to satisfy all complaints about hedge fund fee structures.
However, there is still the issue of the period over which a performance fee is calculated and charged. Most funds charge their fees annually, so if a fund performs well one year and poorly the next, the investor may be left with no return but still have had to pay the performance fee the first year anyway.
One instrument put in place to deal with this phenomenon is the so-called “clawback” by which underperforming managers give back performance fees from previous years. However, such clauses are uncommon. And a few funds calculate their fees over a longer period of time, but again, this is also not terribly common.
The article also mentions one fund, Fusion Asset Management, which employs a so-called shock absorber fee, which “holds performance fees in an escrow account until the investor redeems his investment in the fund. If the fund falls in value, however, the money held in the escrow account is used to top it up.” The fund’s manager, Kirill Ilinski, points out that such a feature makes the fund more attractive to investors, so there is more likely to be a stable asset base. He is so happy with the idea, he is in the process of applying for a patent for the concept.
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