Progress report
An assessment of hedge fund YTD performance in the face of renewed fears for a potential eurozone crash Read More
18/05/2011
Comment: Stephen Oxley
Investing in hedge funds was never cheap and institutional investors dislike fees. As institutions become a growing proportion of the total hedge fund pie, the industry can expect to have increasing fee pressure from its clients. The Dutch pension fund regulator, The Financial Markets Authority, has recently asked pension funds to better understand the costs they are paying; particularly hidden fees to investment managers. In surveys of institutional investors, high fees are often cited as one of the main issues or reasons for not investing in hedge funds.
There is a trend at the moment for some large investors to try and reduce costs by going direct rather than using a multi-manager platform or fund of hedge funds (FoHF). Although investors are also looking to have more control and better information about their investments, the main motivation for this is, frequently, to save money. FoHFs, it is argued, are an additional layer of fees and a barrier to knowing your manager that can be eliminated.
But do investors really understand what their hedge fund programme – whether direct or via a fund of funds – actually costs?
Managing any hedge fund investment programme involves both costs you can see and those that are hidden and unexpected. Like booking a budget airline flight direct online; the headline price of the flight looks attractive but you may end up paying for so many additional charges that in the end you might as well have booked the scheduled service through an agent.
For a direct programme there are consultant fees, direct and indirect personnel costs, professional services such as lawyers, accountants and administrators. Along with set-up costs and ongoing costs there is also something that may best be described as ‘implementation shortfall’ – the cost of not being invested in a strategy because you are spending time putting the programme together.
And what about fees – will direct investors pay more? Because a fund of funds can often negotiate lower fees by aggregating the assets of many clients it is by no means a foregone conclusion that this will cost more than investing direct. An ability to negotiate beneficial fee terms with managers translates immediately into alpha. Every basis point saved on management and performance fees adds to return.
Smaller investments in large hedge funds (which is the nature of most institutional direct investing) are likely to have higher fees than large investments in smaller hedge funds (which is more typical of the way FoHFs invest).
Some FoHFs are cutting their headline fees in order to make themselves more attractive to institutional investors, but, as with the budget airlines example, there is the risk of hidden charges for the investor. It has been customary to charge audit, administration and accounting fees to the fund in addition to the fund manager’s management fee. But investors should be aware that some FoHFs may also add certain personnel, professional services, research, travel, legal fees, due diligence, background checking, risk aggregation and monitoring costs.
Fees and costs matter more to the new breed of hedge fund investor. Institutional investors are also entitled to know the entirety of not just what they are paying but also what they are paying for, and should be able to build a transparent analysis of the total cost of their hedge fund programmes. That way the hedge fund industry can deliver both value and clarity.
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60 seconds with... Kenneth Turchin
CAN YOU DESCRIBE YOUR CURRENT ROLE?
I have worked in public accounting and hedge funds and in the past eight years have been selling middle- and back-office services to the alternate investment industry. My role is to build relationships with clients, teach them about SS&C’s products and services, and ensure seamless transactions every time the firm launches a new fund.
IF YOU WERE DOWN TO YOUR LAST £1,000, HOW WOULD YOU INVEST IT?
I would buy THREE shares in Apple and hope for a repeat 383% return in the next five years.
WHAT WOULD YOU DO IF YOU WERE IN PRESIDENT OBAMA’S SHOES?
That’s one pair of size 12 shoes I do not want to be in!
WHO WOULD PLAY YOU IF THEY MADE A MOVIE ABOUT YOUR FIRM?
Kevin Bacon. He is a versatile actor and the centre of the entertainment universe. I am in sales. Everyone in the industry would be linked to me in six steps or less. My client list would be ridiculous.
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