We’ve mentioned before how institutions are putting downward pressure on the traditional “2 and 20” compensation scheme of hedge funds. Now, despite the upward trend in the markets through 2009 and into 2010, this compensation pressure seems to be gathering strength.
Only 38 percent of global hedge funds surveyed by alternative investment research firm Preqin still adhere to the traditional model, according to a recent story by Financial Times online. The median management fee for hedge funds was 1.5 percent as of December, 2009. Managers are also more open to negotiating special terms with investors, says Amy Bensted, head of hedge fund research at Preqin.
It isn’t that the whole pay-for-performance model is being tossed out the window. Just that investors must be convinced they are getting good value for the performance fees they pay.
Two mechanisms that have helped align managers’ fees with investors’ goals have been hurdle rates (where only returns above a certain benchmark earn performance fees) and high water marks (where funds that lose money have to gain it back before performance fees can be charged again).
Another strategy is the dreaded “clawback,” where an underperforming manager must give back performance fees from a previous year if they hit a rough patch. However, Preqin’s research found that clawbacks have not caught on extensively because many investors feel performance fees are justified when managers do hit their targets for a particular year. You can read the full report on the Preqin website.
What’s your opinion? Are you seeing greater flexibility in fee arrangements between hedge funds and investors? Do you think this is a positive development? Add your comments below.