Element Capital, one of the best-performing major hedge funds since the financial crisis, is sharply increasing its performance fee and shrinking the size of the fund to avoid falling prey to the return-sapping bloat that has affected many of its rivals.
The $18bn hedge fund founded by Jeffrey Talpins, a former bond trader at Goldman Sachs and Citi who has emerged as one of the industry’s brightest stars, already charges a 2.5 per cent annual management fee and 25 per cent of gains, far higher than the industry average.
But by the end of this year, the investment group will raise the levy on any profits it makes to 40 per cent, according to a letter to investors sent out on Monday evening — higher even than some of the best-known funds in the industry — although it will trim its management fee to 2 per cent.
Element also plans to reduce the size of its fund by 20 per cent by the end of 2019. If redemptions after the fee increase prove smaller than that target, it will return a pro rata slice of investors’ capital.*
The changes represent an unusual move for an industry where investors are generally pushing money managers to lower fees of all kinds and few hedge funds ever willingly relinquish any dollars committed.
Broadly, hedge funds’ performance has also trailed behind badly in recent years, souring some big investors on hedge funds. Nonetheless, some players are still able to call their own shots, thanks to their size, performance and ravenous investor demand for the limited space in their top investment vehicles.
“While a seemingly bleak snapshot, a small cohort of funds are prospering,” said Mark Connors, global head of risk advisory on Credit Suisse’s hedge fund servicing team. “Some have even been able to maintain pricing power, distancing themselves even further from the average manager.”
Element Capital earlier this summer shuttered its “portfolio manager programme” of quasi-independent trading centres, but the hedge fund is up 6 per cent in the year through June, according to people familiar with the matter, slightly ahead of the average performance of other “macro” hedge funds, which try to profit from broad cross-market shifts.
Element has averaged annual returns of more than 20 per cent since 2005. In the letter, Mr Talpins indicated that the move was driven by a desire to optimise his hedge fund for performance rather than size.
Many illustrious hedge fund managers have attracted vast piles of investor money over the years only to find it difficult to generate the returns they did earlier. The increased heft made it harder to be nimble in getting in and out of markets without making prices move against them.
While hedge funds typically get a big slice of any profits they make, the big fees they also receive simply for managing the money means that traders with sizeable assets under management can become extremely wealthy even with mediocre returns.
The move by Element bucks the overall trend in the industry, where charges have continued to decline as investors push back after several years of poor performance and mounting cost consciousness.
As a result, the classic “2 and 20” hedge fund fee structure is now nearly dead. Hedge funds charge on average a management fee of 1.18 per cent and performance fees of 14.45 per cent, according to the data provider Eurekahedge.
There has been more pressure on management fees than on performance fees, with funds justifying the latter as an incentivising tool. Only 28 per cent of the assets in the industry are managed by funds charging at least 2 per cent, but more than half are subject to performance fees of 20 per cent or more.
*This article has been amended to clarify the mechanism Element will use to cut the size of its fund
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