The United States District Court for the District of Columbia rebuffed Perry Capital LLC, dismissing its much publicized lawsuit against The Department of the Treasury and The Federal Housing Finance Agency regarding the manner in which Fannie Mae and Freddie Mac profits are distributed.

Perry Capital’s litigation was doomed from the outset. The boiler plate written into the Housing and Economic Recovery Act contained the following provision: “no Court may take any action to restrain or affect the exercise of powers or functions of the Federal Housing Finance Agency as a conservator or a receiver.”

Perry Capital and other plaintiffs had litigation before the Court—litigation so similar that Judge Lamberth’s Memorandum Opinion addressed all complainants as though the litigation had been a class action, which it was not. Perry Capital has filed an appeal.

Lamberth Faults Congress

Judge Lamberth’s conclusion is not without humor and sympathy for the plaintiffs. The good Judge acknowledges that sweeping 100% of Fannie Mae and Freddie Mac profits into the Treasury’s coffers will “raise eyebrows” but the plaintiffs’ “true gripe” is with the Congress that passed the Third Amendment into law, making such action possible.

Lamberth’s tone is reminiscent of Chief Justice Roberts’ statement about the individual mandate in the Patient Protection and Affordable Care Act of 2010, when he said it is not the job of the Court to protect Americans from their own political decisions.

What Next?

Fannie Mae and Freddie Mac saw their share prices plummet almost 44 percent in the wake of the decision, representing a haircut of around $76.1 million for Fairholme Capital Management and Fairholme Funds, Inc., another litigant falling victim to Judge Lamberth’s ruling. Bill Ackman’s Pershing Square and John Paulson’s Paulson & Co. took a substantial hit as well. In fact, only a couple of hedge funds were on the right side of recent events, one of which is Waterstone Market Neutral Fund which held short positions on the stock.

The current administration wants to wind down Fannie Mae and Freddie Mac and there has been bi-partisan senate legislation introduced to accomplish just that. What will fill the void created is uncertain, as are the consequences for interest rates and the housing market, should Fannie and Freddie vanish.

Jobs Impact

Events have yet to play out with Fannie Mae and Freddie Mac, so no firm jobs assessment is possible as it relates to events related to the appeal. However, short term prospects are bleak for employment in larger hedge funds, particularly those holding substantive long-term positions in Fannie Mae and Freddie Mac. Opportunities are more apt to be concentrated in smaller funds, especially those recently benefiting from short positions in these equities.

Smaller hedge funds generally have greater flexibility with management and performance fees, which enhances their ability to attract investors and, of course, they vastly outnumber the large funds. As a result, smaller firms are frequently in the best position to hire qualified candidates because they are growing their assets under management at a disproportionate rate (as a percentage) compared to their larger counterparts.

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With most hedge funds substantially underperforming the major stock market indices year after year since the 2008 financial crisis, it is only natural for hedge fund investors to expect some concession on the fees they pay to hedge funds. However, despite reports of some hedge funds offering to lower asset management fees, it appears that there are a lot of hedge fund investors who feel like they are paying too much for too little with their hedge fund investments. Bloomberg is quoting a large hedge fund investor as saying that 90 percent of hedge fund managers are overpaid relative to their true talent.

Unigestion Holding SA

Unigestion is a large hedge fund investor. The Switzerland-based asset management firm has approximately $16 billion in assets and invests $2 billion of them in about 60 hedge funds. Nicolas Rousselet, who is the head of hedge fund investments at Unigestion says nine out of 10 hedge fund managers are overpaid. He adds that management fees at hedge funds don’t reflect lower interest rates and fund returns.

Hedge funds typically charge 2 percent of assets as management fees irrespective of whether a fund makes or loses money in a financial year. During years of positive returns, hedge funds pocket 20 percent of the profit. For a large hedge fund investor such as Unigestion which has $2 billion in hedge funds, a 2 percent management fee would equate to payout of $40 million every year.

Explaining his frustration with the current fee structure Rousselet says, “The philosophy of the hedge-fund industry, as it should be, is to remunerate true talent. Fund managers should be remunerated when they perform. They should not be remunerated for doing nothing.” Rousselet adds that he prefers a different structure in which the hedge fund industry should either abandon the management fee or combine it with a hurdle rate that must be achieved before collecting incentive fees.

Investor Dissatisfaction With Fees Common

Unigestion invests in 60 hedge funds which gives a lot of credibility to its view that most hedge fund managers are paid more than they deserve. Such dissatisfaction has been felt among other large long term hedge fund investors also.  The largest US public pension fund, the California Public Employees’ Retirement System or Calpers is a well-known example of a firm disappointed with their hedge fund investments. It decided to make a significant cut of about 40 percent to its hedge fund allocation this year after weaker than anticipated returns on its hedge fund investments over several years forced a review of its costs associated with investing in hedge funds.

There are many portfolio advisers who share Unigestion’s view. Simon Lack, founder and portfolio manager of investment firm SL Advisors, says that across the hedge fund industry a lot of funds charge fees they don’t deserve. According to Michael Smith, who is the managing director at Global Endowment Management LP, most hedge funds aren’t worth paying 2 percent management fees and 20 percent performance fees.

Relevance to Job Market

This latest example of investor frustration with high fees adds to the thesis that hedge funds no longer enjoy the kind of clout they once had with investors. Even the continued increase in hedge fund assets is a result of a handful of large hedge funds capturing most of the money. With more and more hedge fund investors pressuring for changes to the traditional 2 and 20 fee structure, the net result is likely to be lower operating capital for many hedge funds. This will likely have a negative impact on the job market especially since many hedge funds are finding it difficult to meet targeted returns in the current market.

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