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February 20, 2013

Aux armes, millionaires!

by Ed Moisson.

So far the impact of the financial crisis has not hit the wealthy as hard as many protesters would like. Even French millionaires have a found an escape from the modern-day guillotine that is a 75 percent tax rate, in the shape of Russian president Vladimir Putin.

But what about the level of charges that high net worth individuals have to pay for investing in hedge funds? Even though there has been some downward pressure on the annual management fees charged, the most common model remains “2 and 20” — 2 percent of the fund’s assets and 20 percent of its performance every year.

In real terms, for a 50 million pound hedge fund that returned 8 percent this could mean an annual fee of 1.8 million pound. The equivalent mutual fund in the UK would typically charge less than half this amount. Perhaps this should be a reason to consider switching to a different fund manager. But European investors have traditionally been more persuaded by the argument that you have to “pay more to get more” than by the notion that a fund manager should minimize costs in order to maximise returns. (Having said this, institutional investors are clearly more savvy when it comes to fees; it helps that they have the clout, through the volume of investable assets, to negotiate).

Yet perhaps the winds of change are blowing. Cantab Capital Partners has launched its Core Macro Fund with a “1/2 and 10” fee structure. The management fee of 0.5 percent (which does not cover back office costs – hedge funds do not typically quote total expense ratios) applies to those investing at least $50 million. Those investing less money will pay more, but still enjoy the 10 percent performance fee. It is hard to argue with Cantab Capital Partners’s assertion that this is “exceptionally low cost” for institutional investors, not least when considering that the fund has daily liquidity and there are neither redemption penalties nor gating clauses. But for performance fee savvy investors, the fact that there is no hurdle rate cannot be ignored. And for those looking for signs of a revolution, Cantab’s other funds have not changed their fees to move in line with the new fund.

There are others that have grappled with the issue of fairness in performance fees, either through the way the fund itself is structured, as with Optcapital, or Aquamarine Capital’s variation on the level of the performance fee. The Aquamarine Fund charges either “1 and 20” or “0 and 25” depending on the share class, with the performance fees subject to 4 percent and 6 percent hurdle rates respectively.

Products with a “no win, no fee” structure are not unique to the hedge fund arena, with mutual funds from the likes of Vinculum entering the fray last year and Bedlam manning the barricades ten years earlier. The Bullhound technology fund also tried this back in 2000 and subsequently closed. Of course mutual funds are also open to the ‘hoi polloi’ who, as we all know, are already revolting, not least in Greece.


There are some signs that millionaires are taking steps to move away from hedge funds. Reuters recently reported that Deutsche Bank’s Alternative Investment Survey showed that family offices and high net worth investors now account for just 4 percent of industry assets, down from 18 percent in 2002.
Having said this, this looks to be a move in search of higher returns, rather than away from higher fees.

In the UK, the blow being struck against high performance fees has come from a more surprising quarter. Here Independent Financial Advisers (IFAs) are those with both the clout and, it seems, the inclination to discourage use of such fees among mutual funds. Their use is most common among funds seeking absolute returns in all market conditions. Many of their strategies mimic traditional hedge fund strategies, and many of them have mimicked hedge fund fees too.

IFAs, most notably Hargreaves Lansdown, have been publicly sceptical of performance fee structures and it looks as though asset managers in the UK have responded. Since the fee structure was first allowed for open-ended funds in 2004, the number of funds being launched with the fee rose to a peak in 2006, but has since declined to the point where only two funds with this structure were launched last year.

Lest we lose sight of the millionaires, it is worth casting an eye to Switzerland, where the Swiss Federal Supreme Court has apparently taken up the mantle of the 1789 Assemblée Nationale and stated that retrocessions, or trail commission, received by banks for asset management services belong to the client.

Although the full implications of this move are still being considered, Ernst & Young have helpfully carried out a survey where respondents generally believe that the Court’s move will improve transparency in the industry, but still the price of bank services (including private banks) are not expected to fall.  The experience in Switzerland so far sounds a lot like that in the UK with the Retail Distribution Review (RDR), which was originally aimed squarely at the man in the street. Perhaps millionaires and the downtrodden retail investor do indeed have common cause.


This column first appeared on Reuters News on 15 February 2013.

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