Hedge Fund Fees Set To Fall

by Carla Johnson, Investors Offshore.com

18 October 2007

A new survey of hedge fund managers conducted by Ernst and Young has revealed that incentive and management fees charged to investors will fall in the years ahead.

According to the research, which polled over 100 top global hedge funds (and fund of funds) managers, and was published by E&Y on Wednesday, the majority of funds (80%) expect incentive fees and management fees to decrease in the next two years. Almost two-thirds also identified increased operational costs as a significant future pressure on fees over the same period.

However, the best-performing funds are still likely to charge a premium for their services with high incentive and management fees, the study concluded.

Julian Young, partner in Ernst & Young’s UK hedge funds practice, commented: “Although pressures on fees may be downward, managers that consistently perform well – both on an absolute and relative basis – will also be able to continue to charge the fee structure they want. The poorer performers will be affected the most.”

Two-thirds of respondents expect their investor lock-in period to decrease in the near future; just a fifth anticipate an increase.

In other findings, the survey showed that retaining the right people (42%) and managing growth (39%) are high priorities for hedge funds over the next year, compared to just 9% who anticipate investing or developing in new products.

“The global hedge fund industry now manages US$2.5 trillion of assets; US$41.1 billion poured in from investors in the second quarter of 2007 alone. The industry appears to be proving that it can handle such inflows. The ability to absorb such flows is only tested by the capacity to grow and retain talent," noted Art Tully, co-leader of the global hedge funds practice at Ernst & Young.

According to the survey, 37% of respondents are confident that their operations meet the needs of their investor base and don’t see a need to change in the next two years. In addition, 21% say that they are likely to be able to offer products suitable for retail investors in the next two years, demonstrating a new confidence for the industry. Only 13% of respondents expect to raise permanent capital in the next two years. The most popular route is deemed to be a partial sale to an external owner; and the greatest interest in raising permanent capital comes from managers in the Far East.

Greater transparency around the valuation process was found to be the foremost medium-to-high level regulatory challenge for 64% of respondents in the next two years; conflicts of interest (57%) and market abuse (55%) are the next key concerns. Valuation and pricing risks were also deemed the second greatest operational risk for managers.

The study found that hedge funds are working just as hard as other financial institutions to ensure they attract and retain the right people. Salary packages (86%) and firm culture (83%) are the main attractions enticing the best staff to join.

Art Tully concluded: “The real concerns for managers, across most of the regions interviewed, were with regards to retaining key personnel, such as portfolio managers, senior researchers and senior operations staff, including compliance and operational risk functions. Managers believe that compensation packages are clearly the most important means of winning the war for talent.”

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