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Comment: Plus ça change

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For years commentators have confidently been forecasting that the days of the two-and-twenty model of hedge fund fees were numbered. As the industry grew, they predicted, fee structures would increasingly vary between the best established and best performing managers, which could ask for – and get – two per cent of net assets annually plus 20 per cent or more of all profits, and the growing number of firms with shorter or less impressive track records, which would have to make concessions to investors to win their business.

For years commentators have confidently been forecasting that the days of the two-and-twenty model of hedge fund fees were numbered. As the industry grew, they predicted, fee structures would increasingly vary between the best established and best performing managers, which could ask for – and get – two per cent of net assets annually plus 20 per cent or more of all profits, and the growing number of firms with shorter or less impressive track records, which would have to make concessions to investors to win their business.

It all seemed logical at the time, but it never happened. As fast as new managers entered the business, institutional investment itself swelled; instead of having to haggle over fees, managers in the second-tier or below also found that they could demand two-and-twenty. When the industry was delivering returns averaging 10 per cent or more, investors had no reason for complaint.

But last year the industry as a whole stopped delivering returns at all; their performance plummeted into the red, and assets shrank further as fearful investors headed for the exits (where they were allowed to do so). Surely now was the time for a new model to replace the two-and-tweny formula, now that investors had the whip hand?

Well, it appears that the answer is still no. According to Olympia Capital Management, there has been little change in fee structures or other standard terms and conditions this year. The firm’s survey of nearly 2,700 managers suggests that the recovery in performance this year has come just in time to swing the balance of power back toward managers – except perhaps in special circumstances where investors have been asked to make concessions to allow funds to be restructured.

One reason is that hedge fund managers may not have a great deal of flexibility in their business model. Performance fees of 20 per cent may be viewed as the icing in the cake, but in many cases it is crucial to ensuring they can cover their costs. And in the end investors are coming back under the same terms because they believe it is in their interests to do so. If they feel two-and-twenty is excessive they can vote with their feet, but many seem to have decided it is a price worth paying. And if the events of the past 18 months are not enough to force a change in the way the industry is remunerated, it’s hard to imagine what will.

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