Last week, hedge fund veteran Richard Perry, who started Perry Capital 28 years ago, decided to call it quits. In his letter to investors, he cited that “the industry and market headwinds … have been strong, and the timing for success in our positions too unpredictable.” Perry is far from alone. With the exception of 2014, which saw a slight increase from the prior year, net hedge fund formation has fallen steadily since 2011. Through March 31, 2016, net fund formation was negative for the first time since 2009. According to Hedge Fund Research, investors redeemed $15 billion from hedge funds over the same time period.
While the redemptions equal less than 1% of industry assets, larger funds are bearing the brunt of these outflows, as pension plans and other large institutions seek to retreat after years of weak returns. The $2.9 trillion hedge fund industry, which in aggregate returned 78 basis points1 year-to-date through August 31 (versus the S&P 500 Index’s return of 7.86%), has underperformed the S&P 500 Index every calendar year since 2008.
This performance shortfall has caused many investors to shift allocations away from hedge funds to lower-cost smart beta products and exchange-traded funds, further perpetuating the headwinds to stock selection. Low interest rates and a surge in stock market valuations have not made it any easier for hedge fund managers to outperform the public markets.
Hedge funds have also drawn increased scrutiny for their fees, which are traditionally a 2% management fee based on assets under management, plus 20% of any performance gains on those assets. This scrutiny has pressured a number of funds to adjust their fee structures. Och Ziff recently lowered the management fees of three of its funds -- which range from 1.5% to 2.5% -- by 25 basis points.2 Caxton Associates cut its management fees from 2.6% to between 2.2% and 2.5% -- but continues to charge a performance fee of 27.5%.3 Tudor Investment Corp. reduced its management and performance fees to 2.25% and 25% from 2.75% and 27%.4 There are likely bigger reductions to come. In a bid to be on the forefront of this shift, fund manager Steve Eisman, who made his name betting on the collapse of the subprime mortgage market and was profiled in Michael Lewis’s book The Big Short, has lowered his fees to a flat 1.25% of assets.
Key Takeaway:While it’s too early to proclaim the death of the hedge fund model, it is clear that investor backlash against high fees and poor performance will require the industry to adapt. If it doesn’t, the music will likely stop for all but those hedge funds that significantly reduce their fees to reflect the persistent low return environment, or are able to consistently outperform the market, net of fees.
1. HFRX Global Hedge Fund Index performance year-to-date through August 31, 2016. 2. “Another Nail in the 2-and-20 Coffin” by Michael P. Regan 3. “2/20 Gone: Average Hedge Fund Performance Fee Falls To 17.6%; Also Under Pressure In Asia” by Rupert Hargreaves 4. “Steve Eisman’s Next Big Short Is Hedge Fund Fees” by Katherine Burton, Saijel Kishan and Katia PorzecanskiThe material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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