hedgeweekLIVE North America: No “one-size-fits-all” in hedge fund fee structures

Lock and keys

The second day of this year’s hedgeweekLIVE North America digital summit featured a lively discussion on fee structures – a perennially-thorny issue in the global hedge fund industry – with panelists delving deep into the emerging trends in incentives and fee models, and exploring the ways in which start-up hedge funds can better align their interests with those of investors.

Moderating the panel, Joel Press, founding member of Press Management, observed how the evolution of the industry from the 1990s and 2000s, through the 2008 financial crisis, to the ongoing Covid-19 lockdown has had a major impact on how clients think about what they pay for in investment products.

Michelle Kelner, senior partner and co-founder of Sandglass Capital Management, which has an event driven and distressed focus on emerging markets, said her firm launched with “enough capital to keep us going”, knowing it would have to establish a two or three-year track record before it could attract institutional capital into its coffers.

“When we did attract institutional capital, we essentially created a founders’ share class by discounting fees for institutions that came in. As we got more traction with more institutions, we’ve discounted those fees less and less and the cheque sizes have needed to be bigger and bigger.”

Offering the allocator perspective, Michael Stein, director and senior portfolio manager, alternative investments at Citi Private Advisory, suggested that well-established managers with long track records and a proven ability to withstand crisis periods can still maintain pricing power and charge higher fees for returns.

But on the flipside, start-ups continue to face challenges, he observed, even though studies suggest smaller, more niche managers often produce better returns over time.

“As investors, the worst thing for us is to invest with a smaller manager in the hopes of accessing a more niche opportunity, but then the manager cannot survive through a tough period because we’ve compressed fees so low that they can’t pay their people. The big behemoths then can come in and hire those skilled people.”

Talk also turned to the various complex and creative fee solutions that have emerged, such as management fees which decrease over time, with early investors benefitting as managers raise additional capital, as well as hurdle structures and 1-or-30 fee models.

The session’s attendee poll found that more than half (56 per cent) of respondents offered a 1.5 per cent/15 per cent structure in their founders’ share class. Close to a quarter, 24 per cent, created a founders’ share class with a 1.25 per cent/17 per cent fee structure. A fifth (20 per cent) still offered the traditional 2/20 model.

“There is no one-size-fits all, but at the end of the day every manager needs to challenge themselves, over what their particular strategy brings to the table and how to best align with their investors,” Stein added.

Panelists also zeroed in on how the manager-investor fee dynamic is shifting when it comes to the role played by alpha, beta and liquidity premia within portfolios.

Faryan Amir-Ghassemi, partner at Epsilon Asset Management, the long/short equity quantitative manager said: “If you’re a source of truly uncorrelated alpha, [then] that is a form of arbitrage that’s valued by the market.”

Asked in a follow-up poll whether management fees may fall and incentive fees could rise following the Covid-19 pandemic, 39 per cent of attendees agreed, while 61 per cent answered no.

Observing the investment opportunities arising out of the coronavirus-fuelled market turbulence, Kelner said: “We want to level the playing field and make it easier for investors to prioritise us in a world where we knew we would be competing with other strategies – risk arb, or equity long/short, or healthcare stocks – for capital.”

Panel discussion 4: Fee Structuring Considerations