By Susan Barreto
A specialist consultant, a fund of hedge fund’s chief investment officer and a single strategy hedge fund manager enter a US public pension fund trustee meeting. And before you think this is the beginning of a corny joke it is not. This is serious. This is a real live group of players that are not able to speak openly and honestly in each other’s presence when the topic of fees comes up.
A silent war is being waged when it comes to fees and despite the mandatory transparency requirements for the hedge fund industry, somehow for fees there is zero and investors have little to lean on. Following the financial crisis most large investors forced down hedge fund manager fees via managed accounts or by funds-of-one, but now the push back is in multi-manager portfolio construction.
When it comes to fees every underhand trick is being played and even Sun Tzu, author of The Art of War, would be shocked. This battle could be bloody.
The theory among pension fund executives has been that funds of funds are the most expensive way to arrive at a diversified portfolio. More pension boards this year are once again looking to add individual managers to their hedge fund portfolios to save on fees.
These CIOs have now devised a new way to get the job done as a battle rages in the distance between funds of funds and investment consultants. Rightly, or wrongly, pension fund CIOs are deciding in ever increasing numbers that FoHFs can no longer charge ‘hedge fund’ fees for services that are tantamount to consulting work.
In the case of Sacramento County Employees, Illinois Teachers’ Retirement System and Colorado Fire & Police, FoHF managers have been picked to structure advisory arrangements that are far less lucrative than the traditional ‘1 and 10’ fee arrangements of commingled accounts.
One pension executive recently told InvestHedge he flatly refused to pay hedge fund fees for a FoHF’s services. It wasn’t a line he felt comfortable advocating other pension plans to take, but a necessity to improve the bottom line of his own hedge fund portfolio.
To survive, some FoHFs are offering side deals to hold on to mandates of over $100 million. For these they will offer to help investment executives research, source and monitor single managers at little or no extra cost to the client. Whether or not this is a sustainable and ultimately healthy long term option is a different topic.
But it seems that at least for now such a tactical FoHF manoeuvre to keep specialist consultants from eating their lunch is necessary. That said, specialist consultants seem to be able to keep up with hiring teams and opening new offices. For example, Aksia recently opened its fifth office for research and advisory purposes in Hong Kong.
Does this mean FoHFs were overcharging investors all along? Or are consultants doomed when it comes to competing with the free research and monitoring being offered by funds of funds?
It is too early to say who will need to back off first from their competitive pricing scheme, but it seems that those pensions with direct hedge fund portfolios at least in 2011 were slightly better off in terms of returns than those that employed both FoHFs and single managers. That statistical anomaly may be due to fees, but it may also be due to the fact that FoHFs are perhaps more broadly diversified than single manager portfolios that seem to be biased toward directional strategies.
Investors focused solely on fees may be missing the big picture and putting themselves at risk of having another portfolio revamp in another year or so, when their current set of strategies need a rethink.
Who will then collect the fee for the advice at that turning point is quietly being determined behind the scenes in today’s institutional market place.