Current Industry Trends In Private Fund Fees

As certain investors continue to seek out passive index strategies, fund managers running strategies that rely on active management have come under some pressure on their fees. In fact, industry tracker Preqin found in a recent survey that 43% of the fund managers they surveyed indicated their clients' primary concern was fee structure, up from 28% in December. Some of this concern is triggered by pension funds that are under pressure themselves to reduce fees, in part, due to their underfunded status. The impact of this has been felt across both hedge fund and private equity fund managers, and many fund managers have been providing investors with alternative fee structures or are considering doing so.

If structured properly, a fund's fee structure can help maintain investor capital and attract new investor capital while creating a sufficient level of revenue from which to compensate and build out a fund manager's team. To enhance a firm's ability to strike the right balance, this article provides a brief summary of some recent developments in this regard.

Hedge Funds

Although the media would have you believe that hedge fund investors are redeeming from these funds in droves, plenty of institutional investors will continue to rely on hedge funds in the second half of this year. Based on a recent Credit Suisse report, although 84% of the investors surveyed indicated that they had redeemed from hedge funds this year, 82% of those redeemers indicated that they would invest their redemption proceeds in other hedge funds. In addition, according to a Financial Times report, U.S. endowments and sovereign wealth funds increased their allocation to hedge funds last year.

However, a fund's fee structure is a prominent factor in investors' minds. Recently, the Orange County Employees Retirement System publicly announced that it no longer wants to pay a performance fee when a fund manager fails to beat an applicable benchmark. This reiterates a call by the investor group, known as AOI, back in late 2014, to better link compensation to performance and reduce a fund manager's incentive to simply gather assets. In addition, AOI has called for clawbacks to be inserted into fund documents to recover performance fees if future losses arise and for a management fee that reduces as the size of the fund increases.

Although a reduction in the management fee as the size of the fund increases is being introduced in various fund documents, a hurdle rate and...