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Hedgeweek Comment: Will the bell toll this time for 2-and-20?

Even some of what seem to be the biggest and most solid hedge fund managers in the world are now having to renege on their promised liquidity in order to avoid having to liquidate assets on a large scale into a volatile and panicky market to meet client redemption requests.

Last week D.E. Shaw Group and Farallon Capital Management became the latest firms to impose redemption gate limits on their funds, faced with unusually high redemption requests - in D.E. Shaw's case, from a fund that has gained around 10 per cent this year, according to Bloomberg.

Both firms invoked restrictions that were already part of their funds' agreements with investors. Those that do not have such clauses are being forced to seek permission to restructure their funds in order to stay in business. Sometimes these efforts are unsuccessful - witness the impending closure of the USD1.2bn Centaurus Alpha Fund after investors refused to accept new terms.

Where investors do sanction a lock-up of assets to protect themselves and their managers from the losses likely from a fire-sale of assets of varying degrees of liquidity, the price tends to be lower fee levels.

This raises the question of whether the current crisis afflicting the industry will finally cause a widespread rethink of the 2 per cent annual management charges and 20 per cent performance fees that have become pretty much standard throughout the industry. Will the more modest fee levels remain in place once the market crisis has passed?

Industry analysts have been predicting for years that most managers would start having to accept lower fee levels, but up to now there has been little sign of it. That may be because of the sheer volume of money that has been flooding into the industry over the past five or six years, or perhaps because the institutions that account for much of the recent inflows are more concerned with the net returns than the level of fees skimmed off the top.

Those calculations may change after a year when the value of the average hedge fund investment is likely to have shrunk by between 15 and 20 per cent. Managers that now need to recalibrate their performance fee high water marks may have to accept that the days of being able to help themselves to 20 per cent of total profits may be over for good.

Similarly, 2 per cent of assets in annual charges may no longer be acceptable to investors after a year in which most managers at best outperformed equity indices rather than delivering the absolute returns in all economic environments that they promise.

It may be too soon to sound the death knell for 2-and-20 as a benchmark for the industry. Since in general the managers that come through the current turmoil intact will be those that have best protected their clients' capital (or better), it may be that their ability to charge high fees will be maintained. But certainly hedge fund fee levels are under scrutiny today in a way they have not been in memory.

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