Hedge Fund Fees Hit New Record, But Trend May Not Be Sustained

by Carla Johnson, Investors Offshore.com

18 January 2006

Despite falling returns and increased competition in the hedge fund industry, hedge fund managers earned a record $16 billion in fees last year, although additional research suggests that overcrowding in the market place is likely to depress fees in the future.

According to Chicago-based Hedge Fund Research, the hedge fund industry increased management fees to 1.44% of assets in 2005, up from 1.27% five years ago.

The 13% increase in fee income has been achieved in a period when the number of funds has doubled to more than 8,000 and annual returns have dipped below 10% from almost 20% in 2003, HFR's data shows.

Hedge fund managers typically charge a management fee of 2%, and take a 20% cut of any trading profits above a so-called 'high water mark', which according to the London Business School's Hedge Fund Centre, is a structure used by about two-thirds of the world's estimated 8,000 hedge funds.

However, the LBS research centre, which is sponsored by BNP Paribas, has suggested that falling returns combined with an explosion in the number of hedge funds in recent times will put downward pressure on the performance fees collected by hedge fund managers.

"There are too many managers chasing too few opportunities using very similar modelling techniques," Narayan Naik, the director of the London Business School's Hedge Fund Centre, was quoted by the Daily Telegraph as observing.

"Some funds will offer lower fees to ensure their after-fee return is higher," he added.

Mr Naik believes that the increasing presence of institutional investors demanding better value has been a key factor in depressing hedge fund fees, and he surmised that the average fee level will fall about 17.5%.

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