Research

The global hedge fund industry has witnessed a trend of declining management and performance fees over the past decade, calling into question the traditional “2 and 20” fee structure the industry was famous for. Mediocre returns over recent years – as opposed to the double-digit annual returns investors had come to expect from hedge funds pre-2008, along with increasing competition within the industry and tighter regulation over alternative investment vehicles are some key factors which have contributed to this trend. Investor experience during the 2008 global financial crisis had resulted in more disintermediation within the industry, with institutional investors engaging hedge fund managers directly. Faced with more proactive and demanding investors, many hedge fund managers ended up lowering their fees, or adopting stricter hurdle rates and shorter lockup periods. Nevertheless, as we will discuss in this piece, a sizeable part of the hedge fund industry has continued to maintain leverage over fees by delivering superior net of fees returns to their investors.

Hedge fund management firms typically charge two kinds of fees to their investors: the performance fee which is based on the amount of performance-based gain of the fund, and the management fee which is charged based on the size of the investment, regardless of the fund performance. Typically performance fee and management fee are considered as the “variable cost” and “fixed cost” of hedge fund investing respectively.

Performance fees often come with additional conditions such as hurdle rate and high water mark. Hurdle rate indicates the minimum amount of performance-based gain that the fund manager has to exceed before charging the performance fee to the investors. Should the fund perform below this rate, the performance fee would be waived during that period. High water mark is defined as the peak value of a fund’s net asset value (NAV) over a period of time. Funds that adopt the high water mark system only charge performance fee over performance-based gains that exceed the high water mark. The high water mark value could be calculated over the whole lifespan of the fund since inception (perpetual high water mark) or over a fixed duration of time such as one year (annual high water mark). In the latter case, the high water mark would be reset at the start of a new period.

Management fees, on the other hand, are often tied to things other than a hedge fund’s performance. Various factors may affect the management fee charged to an investor, including the complexity of the hedge fund’s investing strategy, the liquidity of the asset classes traded by the fund, the lockup period of the investment, and the investment size of each investor. Some fund managers may charge higher management fees while offering other benefits which may include shorter lockup period, tiered fees that decrease as the investment size increases, and being domiciled in a low tax jurisdiction, for example. There are also funds that charge very low management fees while charging higher than average performance fees, vice versa.

The following two tables exhibit the average management and performance fees charged by hedge fund managers in the Eurekahedge Global Hedge Fund Database based on the year of fund launch, as well as investing geography.

Table 1a: Average hedge fund management fees by launch year and investing region

Source: Eurekahedge

Table 1b: Average hedge fund performance fees by launch year and investing region

Source: Eurekahedge

Table 2 below shows the percentage of hedge funds in the Eurekahedge Global Hedge Fund Database which adopt hurdle rates or high water mark provisions in their performance fee calculation. As of June 2019, roughly 81.5% of the live hedge funds tracked by Eurekahedge employ some kind of high water mark provision, compared to the 25.5% which use hurdle rates for performance fee calculation, with 84.2% of these funds adopting either a hurdle rate or high water mark. Approximately 18.5% of the live hedge funds adopt both a hurdle rate and high water mark provision.

Source: Eurekahedge

The following section of the report takes a closer look at the hedge fund industry assets breakdown based on the management fees charged. Figure 1a illustrates the global hedge fund industry AUM breakdown based on the management fee charged.

Following the 2008 global financial crisis, the subset of hedge fund managers charging less than 1.0% management fees has seen substantial growth in assets, reflecting the growing demand for lower fees within the hedge fund investor base. As of June 2019, US$648.8 billion or 28.3% of the hedge fund industry assets were managed by funds charging at least 2.0% management fees. In comparison, fund managers charging less than 1.0% management fees oversaw US$656.5 billion or 28.6% of the industry assets.

Figure 1a: Hedge fund industry AUM breakdown by management fee

Figure 1b provides the percentage breakdown of the industry AUM by management fee. Despite the increasing prevalence of hedge funds charging less than 1.0% management fees, the proportion of assets managed by fund managers charging no less than 2.0% management fees has been relatively resilient to the pressure over the last fifteen years. By the end of 2008, 35.2% of the hedge fund industry AUM were managed by funds charging at least 2.0% management fees. This figure has since dropped to 28.3% as of June 2019. Over the same period, the market share held by funds charging below 1.5% management fees has increased from 30.2% to 55.1%.

Figure 1b: Hedge fund industry AUM percentage breakdown by management fee

Figure 2a provides the global hedge fund industry AUM breakdown based on the performance fee charged. Despite the continued downward pressure on hedge fund fees since the end of the 2008 global financial crisis, more than half of the global hedge fund industry assets is still managed by funds charging no less than 20% performance fees. On the other hand, fund managers charging below 20% performance fees have seen their market share grow remarkably post-crisis, from US$239.8 billion, or 16.3% of the industry assets by the end of 2008, to US$946.2 billion, or 41.3% of the industry assets as of June 2019.

Figure 2a: Hedge fund industry AUM breakdown by performance fee

Figure 2b below provides the percentage breakdown of the industry AUM by performance fee. The increase in demand for lower fees within the industry has contributed to the increase in number of fund launches charging less than 20% fees. However, similar to what we have observed with management fees, a sizeable part of the hedge fund industry has remained resilient to this pressure to lower fees. As of June 2019, US$1,346.6 billion, or 58.7% of the global hedge fund industry AUM was managed by funds charging at least 20% performance fees.

Figure 2b: Hedge fund industry AUM percentage breakdown by performance fee

This section of the report takes a look at the hedge fund industry AUM breakdown based on both management and performance fees simultaneously. With the rise of demand for lower fees, hedge funds charging less than 2.0% management fees and 20% performance fees have gathered significant following post-crisis, growing their market share from US$230.1 billion, or 15.6% of the industry assets by the end of 2008, to US$915.9 billion, or 39.9% of the industry assets as of June 2019.

Figure 3a: Hedge fund industry AUM breakdown by management and performance fees

Notwithstanding the severe scrutiny hedge fund fee structure has been subjected to over the recent years, fund managers charging at least 2.0% management fees and 20% performance fees still account for a not insignificant chunk of the industry AUM as seen in Figure 3b below. These fund managers have seen their market share decline from 34.4% by the end of 2008 to 27.2% as of June 2019. This observation, combined with the growing number of funds charging lower fees would point toward the compression of the two middle categories of funds charging at least 20% performance fees but less than 2.0% management fees, and funds charging at least 2.0% management fees but less than 20% performance fees. The combined market share of the two aforementioned groups of funds has declined from 50.0% by the end of 2008 to 32.9% as of June 2019.

Figure 3b: Hedge fund industry AUM percentage breakdown by management and performance fees

Considering the asymmetric nature of performance fee – in the sense that a fund manager would take share in profits made, but not losses, it is not surprising that there is a strong demand for lower performance fee, as well as other provisions to minimise potential conflicts of interest and deter fund managers from undertaking excessive risk in their investment decisions. Fund managers may also offer customised fee terms to their investors or invest a significant amount of personal capital into the fund, to ensure that their interests are aligned with their investors’. Nevertheless, fund managers who have successfully distinguished themselves by delivering exceptional returns may still be able to attract investor capital without lowering their fees, as ultimately what matters the most to investors is the fund performance net of fees.

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