Hedge funds need to be more flexible with fee arrangements and respond to investor demands for fee alignment, says Albourne chief executive John Claisse, who pointed to the ‘1 or 30’ fee structure the consultant helped develop with Teacher Retirement System of Texas (TRS) as an example.
“When it is working, there is an elegance,” Claisse says. “You are tapping entirely into your share of alpha, and paying for skill.”
As Jonathan Koerner explains in the case study on the $140 billion Texas Teachers, the 1 or 30 structure always pays a 1 per cent management fee or a performance fee of 30 per cent of alpha, whichever is greater. However, following periods when the 1 per cent management fee exceeded 30 per cent of alpha, an investor pays less to bring its share of alpha back to 70 per cent.
Essentially, when alpha is not sufficient to cover the 1 per cent management fee, that fee is paid as an advance on future performance fees.
“What we’re hearing from asset owners is that 1 or 30 revolutionises the conversation,” Claisse says. “It simplifies the focus to [put it] on alpha, and there is an elegance to that. Credit to TRS, they are not just doing it for their own benefit. Ultimately, it stabilises the business model of the manager, which is good for every investor.”
He says some large sovereign wealth funds are asking all their managers to consider these structures.
Furthering this, Albourne has conducted a survey, which 350 funds have completed. It found that more than 40 per cent have adopted a 1 or 30-style fee structure or are considering it.
Claisse says the beta hurdle and performance fee share are negotiable.
“This is not a one-size-fits-all,” he explains. “There are a lot of different types of fee structures for different strategies, but the important thing is they are all focused on the alignment of fees. It’s not the level but the shape of fees that’s most important.”
Fees are fraught
There has been increasing pressure on fee structures from investors, partly because of the sheer volume of fees they pay, but also because there are now genuine alternatives.
Claisse explains that in 2015, (based on a review of more than 600 funds managing more than $1 trillion in assets), hedge funds generated $51 billion in revenue. The investor share of this was only $23 billion, or about 45 per cent, while $16 billion, 31 per cent, went to management fees, and $12 billion went to performance fees.
“That just doesn’t work,” he says.
Claisse, who has been at Albourne for 20 years and, along with its two founders, makes up the executive committee, says the most important trend in the hedge fund space is the activist investor, which is moving the industry forward.
“End investors have the ability to make the hedge fund industry a pool of investable assets that’s attractive as they can be,” he says. “Hedge funds are an efficient business model for deploying risk capital, but they need to evolve to adapt to the current environment and survive. Hedge funds need to change and investors have the opportunity to effect change.”
There has been meaningful progress in fees, he says, but investors can still have a greater impact.
Albourne has been an advocate for fee transparency. In 2013, it launched the feemometer tool for investors. It has also helped managers produce Open Protocol, an industry standard for reporting risk exposures, in effort to empower investors in their negotiations with managers.
Claisse wants to eliminate the ‘angry dollar’ – investors who are unhappy because they are paying for beta or a manager kept a performance fee following a drawdown. The consultant continues to work on fee structure and has an initiative focused on fee disclosure called The Matrix, which includes the scoring of a manager’s fee transparency and flexibility.
“This allows investors to get a more accurate understanding of what they are paying, relative to the alternatives,” he says. “This information can be complex and challenging to obtain.”
Claisse says investors should be asking where they stand relative to other clients.
“Do [the managers] charge 2 and 20 to everyone and have no flexibility, or do other clients get better deals?” he asks.