Hedge Fund Fees: Do Managers Take Too Much?

Rethinking Hedge Fund Fees and Performance

Historically, the standard hedge fund fee structure has been ‘2 and 20,’ or a 2% management fee and a 20% performance fee. The management fee is a percentage of the fund’s net asset value, whereas the performance fee is a percentage of the fund’s profits. However, growing frustration from investors and lagging hedge fund performance is altering the fee structure and allowing more room for negotiation.

Investors often measure hedge fund performance directly against an equity index which is probably a poor reference point, considering hedge funds utilize a multi-asset class mix of investment strategies..

Nevertheless, since hedge fund indices have only recently hit a positive outflow these disappointing returns, combined with high fees, are causing investors to increase pressure on their hedge fund managers.

It is worth noting that if a hedge fund loses money or cannot surpass its high-water mark, the manager does not receive a performance fee. This structure is designed to align the interests of hedge fund managers, who typically invest their own money alongside their investors.

An Evolution in Hedge Fund Fees

A recent survey by Steward and Kissel found that, even in 2023, traditional managers were charging a management fee of 1.8%, higher than the typical 1%.

Despite some managers feeling the pressure, investors are still looking for a greater evolution of hedge fund fees.

While this fee pressure is positive for investors, research by Cliffwater shows that higher-performing hedge funds often have higher fees, suggesting that fees tend to be commensurate with talent. Creating arbitrary fee limits could have unintended results, such as leading to suboptimal hedge fund selection.

Investors should examine returns net of fees to ascertain the value provided by hedge fund managers rather than focusing on absolute fees.

Hedge Funds and Risk Mitigation

Hedge funds can utilize both long and short stocks, bonds, and other investment securities, thereby hedging their market risk. Hedge funds usually achieve returns that are close to stocks, but at a risk level closer to bonds.

Despite recent hedge fund performance or lack thereof, investors still expect hedge fund performance to weather any increased volatility coming in the market, as long as funds keep with a diversified portfolio.

According to HSBC Asset Management, “Whatever one’s views on which macro scenario will prevail, history tells us that in periods of volatility hedge funds can produce returns in excess of other asset classes. We would argue that a well-diversified fund of hedge funds product is a key allocation investors should have as part of their wider portfolios, especially in the current and forecast market environment.”

California State Teachers’ Retirement System (CalSTRS), one of the nation’s largest public pension plans, established a new asset class in 2015 called “Risk Mitigating Strategies” to hedge against volatile stocks that represented more than half its portfolio.

CalSTRS’ CIO at the time Christopher Ailman noted in 2016, “We have a very large bias to growth in GDP in our portfolio. We want to hedge that. We actually want the hedge-fund strategies not for extra return. We are doing the opposite. We think that they actually can be a defensive strategy.”

Despite concerns, 80% of institutional investors believe that if they were to remove hedge funds from their portfolios, their level of risk would increase. Particularly with fees coming down, the short exposure offered by hedge funds is attractive today in the context of inflated public stock markets.

If improperly executed, hedge fund allocations can result in high fees without the returns usually generated. Simply adding hedge funds is not enough — allocations must be managed, fund selection is critical, and access to a diverse range of strategies is key.

In addition, strategy risk and levels of liquidity may make certain hedge funds inappropriate for certain investors. However, with the inclusion of high-quality managers and proper allocation of funds, hedge funds can make substantial contributions to a portfolio.

We think you’ll also like:

1. An Initiation Into Private Equity Funds
2. What Kinds of Green Investments Contribute to the Green Economy?
3. What is an Angel Investor and What Motivates Angels to Invest

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Crowdfunding from the Start-Up’s Perspective
2. Tech Talk: Current Opportunities for Investing
3. How to Access Potential Investments

This article originally published on November 14, 2019.]

©2025. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.