New York: Larry Powell, deputy investment chief for the $16 billion (Rs76,640 crore) Utah Retirement Systems, was convinced in January that hedge funds finally would buckle under the pressure of record losses in 2008 and lower their fees.
He figured it was appropriate to insist on a reduction in the standard industry charge of 2% of assets and 20% of gains on investments as low as $25 million, according to a memo Powell circulated with hedge funds and investors. Performance fees should be assessed only after a minimum return is exceeded and paid over several years rather than annually, he said.
Powell’s plan proved to be wishful thinking. Unlike many private-equity, or PE, firms which have reduced fees, hedge funds aren’t budging without concessions such as longer lock-up periods and commitments of at least $100 million, according to money managers and consultants. While Powell could crow at a June industry dinner in New York that more than half of Utah’s 40 hedge-fund managers agreed to changes in their fees, with four adopting his recommendations, top-performing managers haven’t adjusted yesteryear’s top-dollar fees.
There is no wholesale reduction of fees taking place, said Stewart Massey, who runs Massey Quick and Co. Llc., a consulting firm in Morristown, New Jersey, that caters to wealthy individuals, endowments and foundations.
More demands: A file photo of Daniel Och of Och-Ziff Capital Management Group Llc. The company, whose Master Fund rose 12% in the first half of the year, has had talks about cutting management fees by half a percentage point in exchange for a three-year lock-up and a sizable commitment, according to sources. Adrian Moser / Bloomberg
Daniel Och’s $20 billion Och-Ziff Capital Management Group Llc., Steven Cohen’s $14 billion SAC Capital Advisors Lp and Highbridge Capital Management Llc.’s $23 billion fund haven’t reduced performance fees and are demanding a three-year lock-up in exchange for any cut in management fees.
SAC Capital, which charges 3% of assets and takes 50% of investment gains, may end up keeping fees where they are because market returns are on the rise again, said a person familiar with the Stamford, Connecticut-based firm, who declined to be identified because the discussions are private.
Private-equity funds are having less success holding the line on management fees, which averaged 2% in 2008, according to London-based research firm Preqin Ltd. Companies starting new funds this year are seeking an average of 1.8%. The figure is about 1.65% for offerings with more than $1 billion, Preqin reported.
One reason for the difference is investment performance. Buyout funds recorded a 28% decline in value last year, according to Preqin. That compares with a 19% drop for hedge funds, according to Hedge Fund Research Inc. Hedge funds climbed 9.5% this year through June. Comparable figures for buyout firms aren’t available.
Another difference is liquidity. Private-equity funds tie up money for as long as 10 years. Investors can pull out of hedge funds as frequently as once a quarter.
When a hedge-fund manager reduces fees without seeking concessions, that means they are negotiating from a position of weakness, and that manager must be scrutinized more, said Massey, the consultant. It’s an adverse selection process.
Hedge-fund managers collected fees of about $55 billion in 2007, when returns averaged 10%, according to Hedge Fund Research.
Fees shrank to about $25 billion last year as returns fell the most since the Chicago-based firm began tracking the data in 1990. They will be about $45 billion in 2009, assuming returns and assets under management are constant for the rest of the year.
The industry had $1.43 trillion in assets as of June 30, down from a peak of $1.9 trillion in mid-2008. Hedge funds are private pools of capital whose managers can buy or sell any assets, bet on rising as well as falling prices and participate in profits from money invested.
Hedge funds considering changes have proposed cutting asset-based management fees by half a percentage point for investors who are willing to put up $100 million and not touch the money for three years, said people on both sides of the talks. It’s a commitment that only institutions with multibillion-dollar hedge-fund holdings can afford to make.
Performance fees, the managers’ slice of investment profits, aren’t falling. Some funds are talking about instituting a hurdle, or minimum gain, that must be cleared before they can take their cut, and about collecting the payments over the entire lock-up period rather than annually.
There has been lots of talk, but I haven’t seen lower fees except for new funds, which are charging a 1.5% management fee now, said Larry Chiarello, director of research at Red Bank, New Jersey-based Riverview Alternative Investment Advisors Llc., which farms out money to hedge funds. Established managers seem very unwilling to lower fees on existing funds.
Utah’s Powell wouldn’t comment, citing the no press policy of his Salt Lake City-based employer. The pension fund tumbled 22% in 2008, according to its website. Utah doesn’t disclose performance for its hedge-fund investments or how much it invests in them.
The $184 billion California Public Employees’ Retirement System, the largest public pension fund in the US, told hedge-fund managers in March that it was looking for changes similar to those proposed by Utah. Clark McKinley, a spokesman for Calpers in Sacramento, declined to say if any of its 30 managers had revised terms. Talks with hedge funds have been going favourably, he said.
Calpers lost 23% in the fiscal year ended 30 June. Its hedge-fund holdings fell 15% to $6 billion in the 12 months ended 30 March, the most recent data available.
Supply and demand has helped hedge funds resist fee erosion. Private-equity firms buy companies, hoping to profit by selling them later at a higher price, as well as invest in real estate, debt, infrastructure and venture-capital start-ups.
Investors are less inclined in declining markets to lock up their money for five to seven years, said Brad Alford, head of Alpha Capital Management Llc. in Atlanta and a former managing director of the investment division of Duke University’s endowment. With fewer initial public offerings and corporate mergers, private-equity funds aren’t able to exit investments and return capital to their limited partners, he said.
More than three-quarters of hedge funds charge between 1.5% and 2% of assets, Preqin said in a report published last week. Seven out of 10 funds take 20% of investment profits. Larger funds tend to have higher management fees because they are more in demand, the report said.
Most hedge funds that have reduced fees are new managers or those hoping to keep clients after big losses or redemptions.
Jeffrey Gendell, whose Tontine Associates Llc. in Greenwich, Connecticut, liquidated two funds after losing more than 60% in 2008, was raising money for a new fund this year that charges 1% of assets.
Harbinger Capital Partners, whose assets dropped by about 70% between June 2008 and early this year, proposed that tax-exempt and offshore investors pay a 1.25% of assets and 15% of investment gains in exchange for agreeing to stay in the fund for two years. Those fees are down from 1.5% and 20%. The New York-based firm, run by Philip Falcone, managed $7 billion as of March.
Firms with large institutional clients and strong long-term track records are driving a much harder bargain, including some that manage money for Utah, according to people familiar with the state’s portfolio.
Highbridge, owned by JPMorgan Chase & Co., has discussed a separate share class for large institutions with a management fee lower than its usual 2%. Clients may be asked to commit $100 million or more and agree to keep their money in the fund for three years, rather than being able to exit quarterly, said people familiar with the New York-based firm.
Its main fund, which has $7 billion, climbed 24% this year through July 17.
Stark Investments, with $8 billion under management, has discussed similar arrangements with investors, said people familiar with the St. Francis, Wisconsin-based firm.
Och-Ziff, whose Master Fund rose 12% in the first half of the year, has had talks about cutting management fees by half a percentage point in exchange for a three-year lock-up and a sizable commitment, according to people familiar with the New York-based firm.
Among other managers, Marc Lasry’s $17 billion Avenue Capital Group in New York also has talked about cutting management charges in exchange for a large investment, according to a person familiar with the firm. The performance fee wouldn’t change.
SAC Capital, which recently told investors in its main fund that they could take money out each quarter instead of waiting three years, is considering an institutional share class with a longer lock-up in exchange for lower fees, according to potential investors with the firm. The main fund has climbed 17% this year.
Officials for all the hedge funds declined to comment.
With strong performance to draw in new clients, some managers may decide not to offer any breaks at all because that would cut into their revenue for years to come.
In the previous downturn, a number of managers were forced to lower fees, said Robert Sutton, a partner at New York-based Kirkland and Ellis Lp, who advises hedge funds. It took some time before they could command higher fees for new investments again.
Saijel Kishan and Cristina Alesci in New York contributed to this story.