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Earlier this year, the US$181 billion California Public
Employees’ Retirement System (CalPERS) announced it would restructure its
relationships with its hedge fund managers to achieve better alignment of interests,
more control of its assets and enhanced transparency. CalPERS has the scale and
scope to be able to dictate terms to a much greater degree than other
investors, but the move is indicative of a wider shift that’s occurring in the
hedge fund world and managers are responding accordingly.

Janine Baldridge,
global head of consulting and advisory services at Russell Investments, and
director, research and strategy for its Americas institutional business,
says pension funds are demanding more reasonable fees and more control over
their hedge fund managers in today’s tougher market environment. This is
leading to closer alignment between the investors and the funds, and is likely
to reshape the way the industry operates in the future. “What we will see is
more reasonable investment strategies, and we’ve seen that occur over the years
with less independence of the underlying hedge fund managers to do their own
thing at the expense of their investors,” she says.

“There’s a lot more
discretion in the hedge fund environment and historically some hedge fund
managers have taken a lot of discretion. As this market has more institutional
money, institutions do want to give hedge fund managers flexibility to make
money, but within a certain range. We’re still seeing underlying hedge fund
managers take the discretion that they should, but appreciating that if they’re
a long/short manager, they’re not going to be digging into credit or doing other
things unless they go back to their investors and say ‘here are some good opportunities’.

“It’s appreciating that the investors are long-term investors but only to the extent
that they believe they can articulate what their underlying investment managers
are going to do for them.” Widespread asset reductions across hedge funds and
fund of funds are the major driver behind the trend. “Where really good hedge
funds had redemptions from good firms – they just needed their money back – we saw
a lot offer good terms for new capital coming in,” Baldridge says. While there’s
still not a lot of new capital going into hedge funds or alternatives generally,
Baldridge says newer hedge funds are lowering their fees in a bid to attract
pension funds back to the market.

Watson Wyatt’s Global Alternatives Survey for
the year to December 2008, which analyses the top 100 alternatives managers by
assets under management, found alternative assets managed on behalf of pension
funds by the world’s largest investment managers fell by around 1 per cent to
US$817 billion last year. The modest decline contrasted with a 40 per cent
increase in the amount of alternatives invested with top managers during 2007,
compared to 2006. But it’s not just the new managers that are struggling for
new capital. Baldridge says established hedge funds too are reacting to the
wane in appetite for risky assets, offering to waive the performance fee
temporarily on new capital.

“We have also seen more reasonable terms for
experienced hedge fund managers to say ‘Please give me new capital and I’ll bring
you in at where everyone else is in the fund’,” Baldridge says. “’Your assets
aren’t going to come in with a new clock, where every dollar that I make will
be hit with a performance fee, but you can come in and let us go back up to our
high water mark and we won’t charge you a performance fee on that, and then
once we get back to where we were you and everyone else will all start paying
performance fees again’.

That’s a reasonable, and I think very appropriate, way
to get new capital back in.” Whereas in the past the standard hedge fund fee
comprised a management fee of 2 per cent of the fund’s net asset value each
year and a performance fee of 20 per cent of the fund’s profit, Baldridge says
fees have been trimmed to 1-1.5 and 20. “And we’re seeing some hedge fund or
hybrid hedge fund strategies that are clearly long bets,” she says. “It’s a
fixed income play. Those are being offered at much reduced fees, somewhere
between a long fixed interest manager and a hedge fund fee, because you are
expecting the capital markets to give you a lot of the increase as opposed to a
truly skillful manager looking to buy really good things and short really good
things. “We weren’t seeing that a year or two ago; people were trying to call
beta plays a 2 and 20.”


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