Fees: pay your money and take your choice
Funds in the performance fast lane charge the most for management
If you pay peanuts, you get monkeys, according to the popular saying. Research circulating in the hedge fund industry this month has given weight to the belief by those managers who think this statement is particularly true of them.
A study of fund performance prepared by data provider Hedge Fund Research, which grouped funds together according to their management fee rates, found that, with one significant exception, the more expensive funds generated higher returns for their investors.
The returns were higher even after the fees had been taken into account.
Managers that charged the highest annual management fees, more than 2% of assets under management, gave their investors 2.3% over the year to June and 6.5% a year over the last three years, according to the research.
Hedge funds with management fees of between 1.5% and 2% generated a loss of 4.36% in the year to June. Those charging between 1% and 1.5% made a loss of 7.54%, while those charging between 0% and 1% lost 8.48%.
This pattern, of higher-charging funds generating higher returns, is repeated over three years.
The higher chargers, those with management fees of more than 2%, represented just 2% of all hedge funds. Thirty-eight per cent charge between 1.5% and 2%. Fifty-five per cent charge between 1% and 1.5%, and three out of every 100 charge between 0% and 1%.
That leaves 2% of all hedge funds that charge no management fee at all. They rely on the other element of hedge fund charging structures, performance fees, typically 20% of any fresh gains made by the fund.
Stéphane Ensini, head of business development for funds at bank Banque Privée Edmond de Rothschild, said these managers had foregone management fees because they felt extremely confident of their ability to generate good investment returns.
Investors said managers to do this included the Arrow Select fund and Miami’s Tiverton Investments. The global media fund of London-based Lindsell Train Investment Management did so until October 2007, when the fund was small, a spokeswoman said.
An analysis by Financial News of almost 3,200 fund share classes found only 45 without management fees. Of these, one charges performance fees of 15%, 24 charge 20% and 20 charge more than 20%.
Across the entire sample, five share classes, including three for the Trafalgar Trading fund, take 50% of profits as a fee. One takes 40% of profits. Six levy a 35% incentive fee and 21 retain 30% of their profits. More than 100 charge 25%.
The funds without management fees are those that provide the exception to the rule of higher management fees correlating with higher performance. They made 3.2% on average over the year to June, and 6.7% a year over three years – higher than anyone else.
An investment consultant confirmed that the best returns emerged at either end of the fee spectrum. He said: “The best managers charge no [management] fee, or they charge a lot.”
Christopher Miller, chief executive of hedge fund rating agency Allenbridge HedgeInfo, said: “They have to be so good, experienced and well connected that they can afford to survive on the performance fee alone. Relatively few can, because management fees pay salaries and keep the lights on.”
Rothschild’s Ensini added that some managers charged operational costs such as brokerage individually to the fund.
A manager at one US-based fund of funds said that, while relying only on performance displayed “unbridled confidence, it could also be very dangerous when bad years hit”.
At the other end of the spectrum, he said those who could “get away with charging over 2% as a base fee do because they can – and who wouldn’t?”
Managers charging over the average include Ikos Asset Management’s G10 currency and financial funds, each charging 3.6%; the Superfund in Austria, which charges 6%; while investors have to pay 4% for leveraged versions of Marble Bar Asset Management’s Jandakot and Tomahawk funds.
Gamut Investments, a fund run for asset manager GAM by Bruce Kovner, founder of hedge fund manager Caxton Associates, ramped up both charges, to 4.5% and 30%, but has made 20.5% a year since 1986 in return.
Ensini said: “If a fund charging 3% and 30% were doing better for investors than one charging 1% and 10%, we would still choose the one charging 3% and 30%. What matters in the end is the net returns you get, not the fees you pay to get them. I believe you can’t draw conclusions about anything on the basis of fees alone.”
Allenbridge’s Miller said high charges for hedge funds were “opportunistic and mercenary, and some commentators say it’s not natural for hedge funds to charge their fees, but that’s the law of supply and demand. If you want to consider egregious fees, then look to the long-only world and its 5% upfront charges.”
The funds that have cut management fees below 1.5% – but not to zero – are the greatest cause for concern, according to investors.
Ensini said: “Managers offering lower fees are the ones struggling to survive and attract new inflows, or those launching new funds. A fund charging 1% and 10%, or 1% and 15% would be the one we would look at cautiously, and we would therefore investigate carefully why they would have to have fee levels lower than the standard.”
Phil Irvine, pension investment consultant at PiRho Investment Consulting, said: “Management fees are important at the moment to ensure the viability of hedge fund companies.”
Miller said: “The ones charging only 1% management fees seem to produce peanuts for returns. Charging that sends a message to the industry that the manager is not that good and they have to compete for business on the basis of lower fees.”
Tiverton declined to comment. MBAM, Ikos, Superfund and Arrow did not return calls.
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