Investors pressure hedge funds to negotiate on fees

A year of poor returns is having a bracing effect on hedge funds: they are changing their models and negoting fees.

Global CEO of hedge fund peak body AIMA, Jack Inglis, with local chapter chairman Paul Chadwick. Picture: Hollie Adams

A year of poor returns and fund outflows is having a bracing effect on the hedge fund industry: funds are now changing their business model and making fees negotiable as they try to ride out the market distortions of record low interest rates.

Heading for its first year of net outflows since the end of the global financial crisis in 2009, hedge funds have yielded to pressure from big institutional investors to improve the alignment of their interests, including clawbacks of fees.

“The world of two and twenty is completely dead,’’ Jack ­Inglis, chief executive of the hedge fund peak body, the Alternative Investment Management Association, said.

Rather than paying managers 2 per cent of funds under management and 20 per cent of performance each year, Mr Inglis cited a study by AIMA showing that hedge fund managers were increasingly offering to lower fees as funds under management increased or in exchange for the funds being “locked up’’ for longer.

“More questions are being asked about hedge fund performance globally, the cost of hedge funds — that is, fees — complexity, transparency,’’ Mr Inglis said.

“It seems to have been a lot more concern this year. We want to address it’’.

The comments come ahead of the annual AIMA conference in Sydney today that is themed ­“Deliver or Wither’’, in a nod to a difficult year for an industry that had boomed amid difficult conditions for traditional long-only ­equity, fixed-income and property investors.

There has been a “starburst’’ of new investment styles across the world as banks were driven by ever tougher capital rules to ditch propriety trading and their investment teams left to set up their own funds.

But disappointing performance at the end of last year — particularly in credit strategies — has seen $US23.2 billion ($31bn) flow out of the industry in the six months to March and record fund closures, according to industry monitor Preqin.

Some institutions and family offices switched to other asset classes such as private equity, which are not exposed to regular revaluations that can unsettle ­investors in times of poor performance.

The study of 120 firms found that funds were now more willing to negotiate terms with investors including one in three charging performance fees above a hurdle rate and 97 per cent charging performance fees only above a high watermark, a growing trend towards skin in the game for investment managers and nearly half of managers offering co-investment to clients, rather than just co-mingled funds.

AIMA Australia chairman Paul Chadwick said the fee and ­investment concessions follow pressure from big institutional investors to influence net returns at a time when record low interest rates and a central bank-driven deluge of liquidity has distorted investment markets. Big investors such as the Future Fund had pressured managers to show skill in generating investment return, rather than riding market moves or using leverage to help justify their fees, Mr Chadwick said.

Mr Inglis said two major growth areas had been in commodity investing and private lending — with hedge funds providing the capital for non-bank lenders to meet demand from credit for small and medium businesses at a time when capital rules make it expensive for banks to offer it.