Hedge Funds charging more than 20 percent as performance fees have posted higher net returns in four out of the past six years, according to recent data from Preqin. This data reveals that hedge funds that are at least three years old and have posted positive returns since inception charge a performance fee of 19.50 percent on average. On the other hand, funds with positive returns in less than a quarter of the months studied charge somewhere around 16.67 percent as a performance fee.
Preqin says, “all managers should be mindful that regardless of what fee they charge, if they do not live up to expectations, investors will not hesitate to appeal against performance-based bonuses incongruent to returns, or even exit the fund completely.”
Hedge funds with high returns charge more
Preqin also reveals that hedge funds with the highest long-term net absolute returns are the ones that charge higher performance fees.
Hedge funds reporting the biggest returns for investors on a three- and five-year annualized basis charge more than 20 percent as performance fees. Also, funds that charge more than 20 percent in fees are the ones with the highest risk and adjusted net returns, having a Sharpe-ratio of 2.11 for a three year period versus 1.18 for funds that charge a 20 percent fee.
Investors love to bargain
Despite a clear correlation in fees and returns, clients still bargain for lower fees, according to the Preqin report. The percentage of investors who believe that interests of the fund manager and investor are “properly aligned” has been reduced from 74 percent in 2012 to 64 percent now.
According to the report, around 55 percent of the investors ask for further improvement in management and performance fees. However, Preqin also reveals that a major portion of investors are of the view that management and performance fees have improved over the past 12 months. The percentage of investors noticing such improvement is 68 percent for management fees and 58 percent for performance fees.
Also, some 57 percent of investors bargain on fund terms and conditions, which is an increase from 46 percent in 2012. In not so good news for hedge fund managers, among those investors who negotiate, almost 81 percent emerge as winner.
Investors also ask for hurdle rates or clawbacks
Investors are just not satisfied with negotiations, as 49 percent of investors ask hedge fund managers to alter the structure of performance fees, like using hurdle rates or clawbacks. The use of hurdle rates is more commonly found with hedge funds charging higher fees. Around 68 percent of the hedge funds that charge more than 20 percent fees use hurdle rates, while only 39 percent of funds charging performance fees of 20 percent use hurdle rates. For funds with less than 20 percent fees, the ratio is 51 percent.