Hedge Funds Use Success To Increase Fee Levels

by Carla Johnson, Investors Offshore, London

03 May 2002

Hedge funds have been known as high-return but high-cost investments, but it had been expected that the rush of 'ordinary' money into the instruments during the last year, and growing interest from institutions such as pension funds, would exert pressure on hedge funds to bring their fee structures more into line with that of conventional mutual funds.

According to a report from research group Van Hedge Fund Advisors International, the contrary is happening, with a flight to quality allowing more successful hedge funds, many of which have closed their doors to new money, to increase fees rather than reduce them, and/or to introduce lock-up periods for investors.

Historically, most hedge funds charged an annual 1% management fee and received 20% of any profit they make, with few if any restrictions on the term of investments. John Van, chief financial officer at Van Hedge, says that, while hedge funds fees of 1/20 are still the norm, "Some of the good ones are increasing their fees to 2/20 or 1/25."

Van said that although the average lock-up period isn't getting any longer, managers with good track records have the power to lengthen the lock-up: "We're just starting to see certain hedge fund managers who have a good track record require a two-year lock up."

The Wall Street Journal quotes Thomas Zucosky, senior vice president for alternative investments at Altvest, a hedge fund research unit of InvestorForce Inc., as saying that lock up periods can only get longer as more institutions invest in hedge funds. "Institutional investors are used to long lock up periods - their alternative portfolios are in real estate and private equity, where money is locked up for five to 10 years," he said.

There has been plenty of evidence that the industry is experiencing a boom. Net new hedge fund investment in the US is estimated to have tripled to more than $31bn in 2001, with institutional investment accounting for the bulk of the increase. According to the CSFB/Tremont Hedge Fund Index, hedge funds returned 5.4% in 2001, against a 13% loss for the S & P 500.

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