Investors Chipping Away at Hedge Fund Fee Structures

April 4, 2011

Investors are throwing their weight around, particularly when it comes to hedge fund compensation structures, and it’s having an effect.

One example is D.E. Shaw & Co, one of the world’s largest hedge funds with about $19 billion in assets under management. It recently announced it has lowered its management fees as a result of firm’s less-than-stellar performance in 2010, reports Sify Finance. Though the fund charges 2.5 percent on management, and 25 percent of the investment profits. And that’s still above the industry norm of “2 and 20″ but down from its previous 3 and 30 levels.

Ken Griffin’s Citadel investment funds are also reportedly mulling over a fee cut to calm investors. And several smaller funds are contemplating the same.

Pushing back on hedge fund fees has now become standard practice in the pre-investment stages. Many investors are favoring performance-related compensation over paying fund managers simply on total assets held.

“There’s no way there should be a 2 or 3 percent management fee for a firm that is managing over $1 billion — it’s obscene in my opinion,” says Michael van Biema, who runs van Biema Value Partners LLC, a value-focused fund of hedge funds in New York.

He prefers goosing up the incentive for performance. His firm also commits smaller initial amounts of money to test out a fund, before jumping in with a big investment. “Until you are actually an investor in one of these firms, you may not really understand everything about their operations and investment process,” van Biema said.

Those who are interested in getting a better idea of how potential hedge funds will perform can check out Greenwich Roundtable, a consortium of investment firms. Last year they published a 76-page white paper on best practices for hedge fund due diligence. In highlights tenpotential red flags to consider when considering an investment in an alternative investment manager, such as:

- Overly consistent performance
- Fees that are excessive in relation to a manager’s skill or track record
- Change in an accounting firm, prime brokerage firm or legal counsel
- Lack of an independent administrator to check the pricing of securities
- Track record which is not independently audited
- And more

Information about obtaining copies or joining the Greenwich Roundtable is available at www.greenwichroundtable.org.

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