An old trick for a new alternative – fee slashing
The Financial Times reported today that a growing number of fund managers are starting to slash their management and performance fees in the hope of attracting investors to their (current and new) funds. The report mentioned two funds in particular – $3bn London hedge fund Endeavour Capital and the $2.5bn flagship fund of New York’s Drake Management – offered to waive performance fees until a certain hurdle is reached.
In my opinion, there are two schools of thoughts:
1) Pennies or Dollars? Why would sophisticated investors be concerned with paying 2% management and 20% performance fees if they expect the fund to generate returns that are above that and the risk-free rate combined? Reuters reported (link) recently that the hedge fund industry attracted a record $194.5 billion in new money last year. Mentioned in the same report, Hedge Fund Research (HFR) estimated the average performance of funds to be more than 10% for the year.
Since performance numbers are usually reported in Net terms (i.e. after all fees), investors made money on their investments on the average, even after paying the typical 2%/20% fees. It is probably arguable that these investors would not lose any sleep at night over whether they got a fee discount or not, would they?
2) Fees are guaranteed losses, unless you get lucky. Bloomberg recently published an article on Nassim Taleb, the author of the (in)famous Black Swan and Fooled by Randomness. Taleb attributed most things to luck, and if investors buy into his theory, then the need for fee discounts or waivers become amplified. Fees, even if they are only 2% per annum, are fixed. Although the fund’s performance itself is no guarantee, performance fees are also fixed to a certain extent. Looking from this perspective, on top of taking capital risks (unknown), the investor is paying additional fees (known) to the manager, without any guarantee of recovering those fees. An investor might hence feel that this double layer of risks/fees should be thinned to the minimum where possible.
While investors may leap for joy when being relieved from the burden of (subjectively) high fees, they should also remember the times they last bought anything at a discount or firesale. On the other hand, many predicted the practice of lowering hedge fund fees to continue to attract investors, and this seems to me like the start of the commoditization of an alternative investment product.
When investors start looking at fee discounts and placing them at an equal importance as the other investment considerations (performance, operations, etc), the barrier to entering the hedge fund industry will be raised. Will only the good managers be left then?
Probbly not, but this is another topic for another day. I will leave this post as it is now.
Cheers.
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