Hedge fund managers will be forced to lower their base fees by as much as 50 per cent in coming months if they plan to attract the capital of superannuation funds, asset consultants Watson Wyatt have said.
According to Graeme Miller, head of investment consulting at Watson Wyatt, there has been a “shift in the balance of power, away from the agents back to the principals”.
Miller said that he knew anecdotally of skilled hedge fund managers that had become more flexible in the negotiation of fees, as they realised they needed to secure the long-term capital of investors such as superannuation funds.
“Managers have found that fund-of-hedge fund money is fickle,” Miller said. “The most liquid funds have been redeemed first, regardless of whether they were doing what they were supposed to do. Fund of funds are withdrawing wherever there is liquidity.”
“Funds managers have been calling the shots for quite some time, but we are about to see a significant reversal of that,” Miller said. “While it is too early to tell how far that balance will shift, we wouldn’t be surprised if base fees came down by 50 per cent (100 basis points for the standard ‘two and 20 model).”
Hugh Dougherty, head of manager research, said that while Watson Wyatt believed skilled managers should be fairly compensated, fees were generally still too high for the value they delivered, particularly as were entering a lower-return environment.
“Performance fees introduced to align interests have been less than effective because they are generally poorly designed and tipped in managers’ favour,” he said. “For a number of years we have been trying to rectify this situation and negotiate a fairer deal on fees, but only now are we seeing real progress.”
Watson Wyatt also predicted there would be “significant consolidation” in the hedge fund industry in coming months, as the financial crisis and “unprecedented changes to the regulatory landscape” forced many hedge funds to close.
In a note to clients, Watson Wyatt said the outlook was worst for fund-of-hedge funds and fixed income managers that used high levels of leverage.
Multi-strategy managers would be well placed to capitalise on opportunities and were arguably less affected by legislative changes, although some have very illiquid assets which combined with large redemptions could cause problems. Likewise,
credit focused managers that did not rely heavily on leverage were likely to benefit, although it would be important to distinguish between opportunities that require hedge fund skill (e.g. distressed debt) and those that are more long-only in nature and should be accessed more cheaply.