The business of hedge funds is caught between rising costs and falling management fees, holding little profit for managers who do not perform.
That's one key finding from the second annual global survey of the economics of hedge funds in the just-released Citi Prime Finance 2013 Business Expense Benchmark Survey.
According to the survey, the traditional "two and 20" model of investment manager compensation – two per cent management fee and 20 per cent of the profits – has declined to fee levels as low as 1.58 per cent of assets under management for all but the largest managers.
As a result, hedge fund managers, unlike their counterparts in traditional, long-only funds, barely break even simply collecting fees. For example, after paying expenses, funds with USD500m in AUM realise operating margins of 69 basis points, rising to 82 basis points for a manager overseeing USD900m, survey data show.
"Fee compression continues to reshape the business of hedge funds, lowering fees even as expenses rise, all but eliminating fee-only operating margins, and raising the level of assets needed for a hedge fund business to succeed," says Alan Pace, global head of prime brokerage and client experience. "And while it's clear that there is little room for additional downward pressure on management fees, at current average fee levels, investor-manager interests are well aligned – both parties are focused on performance."