Rethinking hedge funds

The first quarter was the worst for hedge funds since the financial crisis. Many see the reasons for the bad performance in the funds’ structure. Fees have to be transformed and liquidity is a bigger issue for investors.

The first quarter was the worst for hedge funds since the financial crisis. Moreover, it is the first time since 2009 that funds have suffered from net outflows in two consecutive quarters. Much of this is due to the dissatisfaction of investor with the funds and their low performance. In a recently published review, Man Group sees the high fees of the funds as well as the risk budgets as a trigger of losses. While a management fee of two percent and a performance fee of 20 percent reduce returns for investors, losses beyond the risk budget of the funds make it harder for managers to recover after losses.

Besides Man Group, Unigestion calls for a rearrangement of fees too. Similar to Man, Unigestion claims that fees can be structured in a way that is feasible for investors and managers and aligns their interests better. Unigestion thereby says that investors can reduce fees in two ways: First, they can make use of liquid alternatives that deliver robust returns more cost efficient and second, they can transform a fund’s fee structure. Depending on fund characteristics such as return expectation, investment strategies and operational costs, an investor might ask for change in the fee structure to, for example, a one percent management fee and a 30 percent performance fee. Thereby, incentives setting can be improved.

In a recent article outlining key considerations when starting hedge funds, Dechert notes that “the traditional 2/20 models been under stress due to recent lower hedge fund performance.” Instead, they advise manager starting their funds in 2016 to impose more investor friendly fees. Such include a reduced management fee of 1.5 percent or introducing a hurdle rate of returns to be reached before performance fees are payable.

Moreover, Dechert claims that liquidity came to the investor’s attention. Besides making timely redemptions, the article “Launching a Hedge Fund in 2016: An Overview of US Managers” advices wannabe managers to introduce effective tools to maintain liquidity. Such can be gates limiting redemptions to a maximum per day, in-kind redemptions that allow time to dispose illiquid assets, reducing redemption frequency or the suspension of redemptions.