Many hedge funds faced performance problems last year, and the industry as a whole has been rocked by increased scrutiny, but that isn’t keeping institutional investors away. Hedge funds are also facing increased competition, and as a result, management fees are under pressure with investors being less and less willing to pay 2% management fees and 20% performance fees on their investments, according to a recent survey.
Institutional investors renegotiate fees with hedge funds
JPMorgan’s Capital Introduction Group issued the results from its 13th annual Institutional Investor Survey. Among the key findings was that 40% of the 332 firms that took part in the survey negotiated fees in 2015, which is a slight increase from the 38% that negotiated in 2014. The survey also indicated that 80% of those that negotiated fees, 80% negotiated both performance and management fees.
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But while a fairly high percentage of investors negotiated fees, JPMorgan found that just 31% of respondents didn’t have to make any concessions in their negotiations. That’s a significant decline from 2014 when about half of them didn’t have to compromise on their demands. Among the concessions were increasing their allocations to the hedge funds, longer lock-up periods, and redemption terms with less liquidity.
Hedge fund fees on the decline
We’ve seen numerous firms cut their fees to all-time lows in an attempt to retain and attract investors, so these findings aren’t very surprising. JPMorgan also reports that investors have been able to chip away at the fees they’re paying and now pay less than 2% in management fees and 20% in performance fees.
The firm reports that 94% of survey participants pay an average management fee that’s lower than 2%, and the percentage of institutional investors paying between 1% and 1.5% rose to 32% last year from 27% the previous years. About 60% of participants pay between 1.5% and 2% in management fees, and almost 80% of participants pay less than 20% in performance fees.
Hedge fund allocations still on the rise despite underperformance
JPMorgan reports that institutional investors are also very supportive of hedge funds despite the problems that have plagued the industry as the vast majority has continued allocating heavily to hedge funds. Of the 87% of survey participants that made new allocations to hedge funds last year, 94% invested in new funds, and two-thirds added to their current investments.
The firm also noted that the increased allocations came even though 2015 was difficult for many portfolio managers. In aggregate, hedge funds underperformed the majority of major market indices again and correlated highly to global equity markets. The underperformance did still impact allocations, however, as at the beginning of last year, almost 30% of respondents said they planned to increase their allocations to hedge funds as a percentage of their portfolios. At the end of the year though, just 11% said they actually did.
JPMorgan found that like in 2014, 80% of participants maintained their allocation levels as a percentage of their portfolio. This year the firm expects continued activity in the hedge fund industry but also believes that this year will focus on manager turn over and “new allocations from recycled capital, as investors attempt to reallocate amongst different managers and strategies to meet return targets for 2016.
Investors more careful about new money managers
The firm reports that 2015 was difficult for new hedge funds and younger managers as institutional investors set a high bar in their evaluations. Fundraising was difficult in 2015, although still 42% of survey participants allocated some money to a startup. Looking ahead, 80% said they expect to maintain the number of startups they allocate funds to this year.
Further, only 15% said they allocated seed or acceleration capital to startup managers, illustrating just how difficult the fundraising environment was last year.
Investors prefer Long/ Short Equity hedge funds
JPMorgan reports also that the most popular hedge fund strategy among institutional investors has been Fundamental Long/ Short Equity funds since 2008 with 90% of participants investing in the strategy last year.
All graphs and charts in this article are courtesy JPMorgan Prime Brokerage.