Most Hedge-Fund Managers Are Overpaid With Fees

Most Hedge-Fund Managers Are Overpaid With Fees, Unigestion Says

Nine out of 10 hedge-fund managers are overpaid as management fees don’t reflect declining interest rates and fund returns, according to Unigestion Holding SA, which invests $2 billion in hedge funds.

The fees, which still make up as much as 2 percent of a fund’s assets, represent a disproportionately high share of the total remuneration unrelated to performance, said Nicolas Rousselet, head of hedge funds at Unigestion. To align managers’ pay more with performance, the fund industry should either abandon the management fee or combine it with a hurdle rate that one must achieve before collecting incentive fees, he said.

“The philosophy of the hedge-fund industry, as it should be, is to remunerate true talent,” Rousselet said in a telephone interview on Sept. 9. “Fund managers should be remunerated when they perform. They should not be remunerated for doing nothing.”

Fees are coming down amid efforts to win mandates in an industry that traditionally charges about 20 percent on performance and 2 percent on the total assets. Investors paid an average 1.69 percent last year, with the share of those who paid 1.5 percent or more at 79 percent, almost unchanged from 2012, according to a Deutsche Bank AG survey published in February.

Global hedge funds returned 8.6 percent in 2013 and 6.9 percent in 2012, compared with 10 percent to 21 percent in nine of the 11 years through 2010, according to Singapore-based data provider Eurekahedge Pte.

BlueCrest Capital

Unigestion, based in Geneva, manages $16 billion, of which $2 billion is invested in about 60 hedge funds through its funds of hedge funds, said Rousselet.

Among hedge funds that have taken steps recently to trim what they charge was BlueCrest Capital Management LLP, which said earlier this month it cut management fees on its $8.2 billion computer-driven hedge funds to 1.5 percent from 2 percent after assets tumbled in the past year.

“In a low-rate, low-growth environment it is far more difficult to justify high management fees,” said Keith Pogson, a Hong Kong-based senior partner for financial services at Ernst & Young Global Ltd. “Hedge-fund managers should work harder to justify the fees that they earn.”

Ninety-four percent of Unigestion’s assets come from about 250 institutional clients and 6 percent from high-net-worth families, according to the firm’s website.

Unigestion’s head of marketing Jean-Francois Hirschel declined to elaborate how much the firm charges its clients for selecting hedge funds. He said that the firm’s share is about 10 percent of the clients’ total expense.

Fee negotiations “continue to become a more accepted practice for investors and managers globally,” according to the Deutsche Bank survey. Seventy-four percent of respondents said they negotiate fees, up from 51 percent two years earlier.

“We are negotiating with hedge-fund managers,” Rousselet said, adding that he doesn’t see management fees trending down. “But if you buy a top manager, the bargaining power is not in your hands.”

I’d like to be an overpaid hedge fund manager.

…and in NFL related news Sam Bradford was quoted as saying “Most NFL players are overpaid, they should be remunerated when they perform”.

At least the NFL doesn’t have guaranteed contracts.

Hedge funds don’t have guaranteed contracts either for the most part. Most investors are no longer willing to sign a lockup and everyone is now focused on monthly returns. Imagine if an NFL coach was hired and then immediately fired if he lost a couple of games.

Most funds are overpaid. There are some funds that generate exceptionally good returns though and investors fight tooth and nail to get into those. I know one guy that opened up for $100mm and had $2B of demand for that spot lol. He ended up taking money from friends only.

what is this short term focus nowadays…thats not investing. i think lockups are still a good idea. the manager is not forced to get into something they are not comfortable with. are the days of investing over???

Generally, my response to those claiming someone is overpaid is “why do you go do the job then?”

The market, in general, results in fair compensation. Like bro said, guys fight for quality managers. If you think they’re overpaid, then go be as good as them and get overpaid too.

Honestly, yes. Try to find an LP who doesn’t ask for monthly returns.

I think a lot of people underperform strictly because they have the wrong LP base and have to stupid stuff to manage for monthly numbers. Lots of people would underperform anyway but that’s definitely a part of it.

My point wasn’t so much a commentary on NFL compensation as much as I was trying to point out it’s ridiculous for a fund of fund manager to call HF managers overpaid.

Lockups should be strategy dependent…they make a ton of sense in certain cases and would be silly in others.

Many managers are now offering reduced fees for longer lockup periods. A fund I’m working with now has 3 options, 2% mgmt fee for no lockup, 1.5% mgmt for 1 year, 1.25% for 2 year. It’ll be interesting to see if this becomes more popular

Yes, if you’re doing illiquid stuff, lockups are pretty essential. Otherwise, if people want to time the market by jumping in and out using their emotions, they deserve what they get.

With 2+20 a 10% gross return is a 6% net return. Yep, I’d say many HF managers are overpaid. But, fees are coming down rapidly.

I mean honestly no one is really looking to pay 2/20 for a 10% return. It happens but that’s a disappointing outcome. A 15% CAGR is top 10% in the hedge fund world, a 20% CAGR is top 1%. It’s worth it to pay for a 20%+ CAGR, no question about that. It might be worth it to pay for a top 15% CAGR as part of a portfolio strategy for the allocator but it depends on the specifics, IMO. One example I know of is a healthcare only L/S fund with a long-term 15% CAGR (this puts the fund in the realm of top 5 or 10 healthcare only funds, I believe – in absolute numbers, not % of healthcare funds). A FoF or family office that wants healthcare specific exposure as part of a portfolio construction strategy might make that allocation and it could make sense for them.

Obviously it’s hard to consistently be in the top 1% of funds over a long time period by definition but there are funds that do this. Probably now someone who doesn’t know what they are talking about will come in and say that’s luck or there is no way to determine luck vs. skill but that’s obviously wrong, let’s try not to let the conversation devolve into that. Most LPs would be lucky to get into a 20%+ CAGR firm if they could find one willing to accept their money.

Another key consideration is net exposure. A +10% CAGR for a beta neutral fund is appealing to a lot of LPs as that is effectively 10% of alpha with no market exposure and that fund should, in theory, perform well in a down market, acting as a hedge to the total LP portfolio.

So bromion, how do you go about establishing if there is skill, or is past performance in the top 1% all that you really need to know?

The challenge with market neutral funds is that in a crisis, they become very difficult to rebalance to keep beta neutral. In normal times, it’s great to get uncorrelated returns, and those are often worth paying for even if they are sub-10% (as long as the correlation is truly low), but it’s a mistake to think that because the beta is neutral, market neutral funds won’t be taken down in a crash.

I could give you lots of specific examples of specific strategies that work and could be verified to work, but I refuse to even start that discussion. The only people who think that are people who don’t know anything about the hedge fund industry and there is no way I am going to convince any of them to depart from their wrong beliefs.

A well constructed market neutral portfolio will have a long book that declines but its short book should decline a lot more.

Are we considering the “SAC strategy” skill or luck? At any rate, I do know there are some people who know what they are doing. But a consistent winner (as in, every year not over a period of time) always makes me skeptical Steve Cohen gave them a lesson or two.

Establishing skill seems to be mostly about seeing if the strategy makes sense, if the HF team genuinely has the chops to execute it, keeping an eye on how AUM size is related to the opportunity set, and to figure out how the risk control works. But I suspect that can only help down to the top quartile or so. If you are top 1% consistently something smells fishy. Either there is loading up on fat tail risk (selling option premiums and levering) or some kind of insider trading or market manipulation. But I understand how it is important to talk a confident game.

As for shorts going down faster than longs, in a crash, that only happens if the shorts you’ve spotted are totally unique to you. In 2007, quant funds running market neutral strategies found that heir longs declined and their shorts often went up. That was because everyone else was closing their shorts at the same time.

I think the issue is identifying top1% before they become top 1% or investing in top 1% that will continuously to be top1%.

Like you said, there’s a lot of strategy that work and verified to work. Most of them requires some type of discretion and this is where soft/hard lock comes in. Market neutral is probably one of the few strategy that I have little or no confidence for precisely the reason bchad mentioned. I went through that period of short squeeze and it’s not interesting at all. I had a re-think about whole protfolio post that period. Suffice to say, my attitude towards HFs changed a lot. I now prefer to write ticket and willingly ask for lock up in exchange for lower fees. I also prefer not to deal with equity based strategies. Too much of their destinay is in other people’s hand.

To respond to the topic, I like to see the industry to transform into something like “first $1b is 2% and thereafter is 0/30”…I think that’s enough said.

SAC clearly cheats / cheated. That’s probably to be expected at any firm with that many people though (I’m not defending them, but I’m not surprised at all).

The AUM constraint bchad mentioned is key. A lot of the top 1% funds are sub-$1B of assets. I am talking about a smoothed CAGR over a long time period (5-10 years or longer) though, not necessarily top 1% every single year. A lot of the top 1% funds do something relatively similar. I’m not going to say what that is obviously. At least that is true for the half dozen or so fund managers I know in the top 1% over decade plus time periods. If you sit down and talk to someone who compounded at 25% over a decade or longer vs. someone who did 15% there is a very clear quality and skill difference just in talking with them, and you can see it playing out in their 13Fs if you know what to look for.

The other key aspect is having the right LP base. If you have a bunch of hot money LPs, you have to focus on hot money strategies, which virtually guarantees you will not be a top performing fund over time no matter how good you are. All the best performing funds I know have captive capital, either personal wealth or a very select LP base. Most “hedge funds” do poorly over time simply as a result of having the wrong business structure, though that’s hardly a crticism since most funds are lucky to be in business at all and would take money anywhere they can get it.

You can’t really compare quant strategies, which are nearly a pure commodity now except for a few very special funds like RenTech which literally have data not available to many people because they have been in that game so long and tracking EVERYTHING since the 1970s, including datasets you can’t even buy if you had the money to. Specifically they have historical order book data which is not for sale anywhere from what I have heard.

My preferred stucture after the first $50mm of assets is 0/25 with a high water mark though I would definitely take 0/30.