Hedge fund investors are sick of paying for "skill-less returns"

Institutional investors have grown tired of paying fees to hedge funds for what they see as “skill-less returns.” 

Roughly two dozen pensions, endowments, sovereign wealth funds and others — with more than $200 billion in combined hedge fund investments — are demanding changes to how the money managers get paid.  

Investors led by the Teacher Retirement System of Texas are seeking performance-fee hurdles, according to an open letter to the hedge fund industry published Thursday. The coalition wants hedge funds to forgo incentive fees until they generate returns that beat 3-month Treasuries, which now yield more than 5%.  

For years, hedge fund fees have frustrated investors. The biggest and best-performing funds often charge clients 2% of assets managed and 20% of profits. In 2019, Element Capital Management famously jacked up its incentive fee to 40%. It has lost money over the past three years.

In 2023, average management and performance fees hit the highest since at least 2015 — 1.7% and 17.7%, respectively, according to a January report from Goldman Sachs Group Inc. Multistrategy funds, which pass along a variety of costs to their investors, are even more expensive. Last year, clients of such firms received 41 cents of every dollar earned by funds that passed on all costs, down from 54 cents in 2021, according to a BNP Paribas SA prime brokerage report. 

Cash hurdles will fix a “misalignment that has been present in fee structures throughout the maturation of the hedge fund industry,” the investors, known as limited partners, wrote in the letter. They include University of Texas Investment Management Co., Singapore sovereign-wealth fund GIC Pte and Canadian pension fund Caisse de Depot et Placement du Quebec.  

With interest rates elevated, hedge fund managers have been able to collect incentive fees on returns that required little skill to achieve, according to the investors.

“Earning cash returns is not the reason institutional LPs invest in hedge funds,” they wrote.

Last year, a $1 billion hedge fund could have made about $52 million just from holding cash, the signatories said. If the fund charged a 20% performance fee, that would translate into more than $10 million “for taking zero risk.”

This isn’t the first time the Texas teachers pension, which has about $20 billion invested in hedge funds, has led the charge for more favorable fees. 

In 2016, it urged money managers to adopt a “1-or-30” structure. That means a hedge fund would charge the greater of a 1% management fee or a 30% cut of gains in excess of a benchmark.