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Hedge fund fee model morphs from ‘two and 20’ to ‘one or 30’

Fund management

Hedge fund fee model morphs from ‘two and 20’ to ‘one or 30’

Chart of the week: investors drive harder bargains after years of disappointing performance

The traditional “two and 20” fee model used by hedge fund managers has almost vanished as investors have determined to strike better value agreements after repeated years of disappointing performance.

JPMorgan Chase surveyed 227 institutional investors with a total of $706bn in hedge fund assets and found that just 5 per cent paid a management fee of 2 per cent or more last year.

Forty-six per cent of respondents — an increase of 11 percentage points on the previous year’s survey — paid a management fee of less than 1.5 per cent.

Performance fees, however, remain high. Nearly half the respondents paid performance fees of between 17.5 per cent and 19.9 per cent. Only one in 10 respondents paid a performance fee of less than 15 per cent.

Tension over fees between managers and clients appears to be rising. For the first time in the survey’s 16 years, more than half (52 per cent) of the respondents were either negotiating or looking to negotiate fees.

Michael Monforth, global head of capital advisory at JPMorgan Chase, said there was recognition among investors and managers of the need for a better alignment of interests, leading to more flexible fee arrangements including discounts for loyalty or large allocations.

JPMorgan also found that 17 per cent of its respondents had implemented a “one or 30” model. Under this, an investor pays a 1 per cent management fee that switches to a 30 per cent performance fee once a performance target has been reached.

Concern that too many hedge funds are chasing the same limited opportunities for alpha (market-beating returns) were cited as a worry by four-fifths of respondents. Even so, almost a third expected to increase their exposure to hedge funds this year while 55 per cent would keep their allocations unchanged.

This may look like good news for hedge fund managers but more investors are determined to drive a hard bargain, with 85 per cent of those surveyed saying they expected fee reductions in 2019.

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