“If I can buy four yachts from my investments, why should I care if my manager can buy one
for himself?”
This quote, from an investor in hedge funds, encompasses the argument for the much-pilloried incentive fee hedge funds levy, usually set at 20% of profits.
Hedge fund managers are frequently attacked as overpaid and greedy, mainly on the basis of this structure. But it is a key pillar in their contention their interests are aligned with investors in a way their long-only peers are not.
When it comes to fees, the migration of some practices initiated by hedge funds might be welcomed by long-only investors.
Many hedge funds, and some long-only managers, may only collect incentive charges after achieving a predefined return – usually Libor plus a bit, akin to “my manager has to pay me one Mercedes, before buying himself a yacht”.
Most may only retain 20% of profits after retracing any losses they have made, or reaching their high watermark. Long-only investors, by contrast, fork out even when their fund falls, or when it is retracing gains it already made once, or many times before.
An increasing number of hedge funds are putting the performance fees they earn each year into an escrow account, and allowing investors to claw back a portion if the fund subsequently fails to deliver – tying their fortunes to consistent returns, in other words.
One listed fund of hedge funds, Altin AG, takes the highly unusual step of actually limiting its managers’ pay packets. Altin charges 5% of the gains it makes up to 12%, and then 10% on gains between 12% and 20%. But if Altin makes more than 20%, that is all for the investor.
Eric Syz, a member of Altin’s board of directors, explains: “We do not want our manager to take undue risks, which can happen if a manager is pushed to make 35% or 40%.”
There is nothing like capping a pay packet, at a reasonable level, to curtail a manager’s appetite for risk taking to grow it.
RDR will bring a greater level of transparency, and possibly a wider variety of share classes, but it is to be hoped it brings newer charging and remuneration structures that rewards long-term performance, as a opposed to short-term mediocrity.
