Investors pay higher hedge fund fees for first time in a decade

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Investor eagerness to allocate more money to the hedge fund industry’s costly mega-managers has driven up average fees for the first time in a decade.

Management and performance fees fell every year between 2014 and 2023, according to a survey by BNP Paribas of 238 hedge fund investors, except for 2020 and 2021 when the French bank did not record the data, as investors pulled money from the industry following often-lacklustre returns.

However, annual performance fees increased to 17.82 per cent this year from 16.91 in 2023, the survey showed, the highest level since 2016. Management fees increased to 1.54 per cent from 1.46 per cent last year.

Hedge funds have historically been known for a “two and 20” fee model, where investors pay 2 per cent in management fees every year and 20 per cent on any performance gains. In reality, investors rarely pay fees that high, especially for small to medium-sized hedge funds.

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The 2024 increase in fees reflects how global investors are allocating billions of dollars to multi-manager hedge funds that emulate Ken Griffin’s Citadel and Izzy Englander’s Millennium and which have come to dominate the industry.

These firms pursue expensive models that can rely on hundreds of portfolio managers trading a variety of strategies across markets, and so charge higher overall fees than the average hedge fund. Many have consistently made large gains for investors, even during downturns in the equity markets.

These firms often charge performance fees of 20 per cent. Marlin Naidoo, head of capital introductions at BNP Paribas, said allocators had allocated money to the large managers who tend to have higher performance fees, pushing up that figure.

Some multi-managers do not charge management fees, with many opting for a so-called pass-through model where they charge all expenses, including salaries and technology spending, directly to investors. In practice, the pass-through model is equivalent to fees on investor assets of between 3 and 10 per cent.

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BNP’s survey does not count the pass-through fee as a management fee, but does take account of the multi-managers that do charge a management fee, which is often above the industry average.

“[Investors] have also allocated to funds which pass through some costs to investors that also charge a management fee of 2 per cent or higher, which has resulted in a jump in fees paid,” added Naidoo.

The pass-through model is controversial with some investors, who argue it does not incentivise management to keep costs down. BNP Paribas’s survey showed that last year investor returns from managers that did not operate the pass-through model beat hedge funds that did.

The Financial Times has previously reported that some multi-manager hedge funds that do charge a pass-through, such as Balyasny and Schonfeld, had a disappointing year for performance in 2023.