By Susan Barreto
The hedge fund hockey match just got a bit more interesting, as the puck is batted by investors toward the goal and the goalie is more than a little reluctant to protect his net.
The team hedge fund goalie may be getting tuckered out too. It seems that now hedge funds have shown a willingness to negotiate there are a multitude of new terms and fee structures to choose from.
For pension funds, the playbook has been drawn up largely by US public pension funds - with Utah's Larry Powell giving strategic input to the industry in a white paper. Among other things it proposed that hedge fund managers implement a tiered management fee structure so that large investors do not subsidise an undue portion of operational costs, a move that was later embraced by the fund of hedge funds community as well.
All in all, institutional investors have expressed dissatisfaction with fees and have applied pressure en masse. And the pressure has been global. A new survey from bfinance found roughly a quarter of pension funds surveyed anticipate lower performance fees in 2010.
Another 25% of pension funds are prepared to concede to a lock-up in exchange for lower fees, and following the market volatility sparked by the financial crisis, pension funds are suggesting that performance fees be calculated over a longer period. The preferences vary with the majority opting for performance fees to be calculated over more than a two-year period.
So far it seems that hedge fund managers have allowed the investors to score the first and second goal of the match in lowering management and performance fees in tiered structures, but the second half of this face off may see some unprecedented defence.
The third and fourth period of this unique hockey match will be dominated by fund structures and will require more of a buy-in from investors who need to decide if their objectives are indeed united.
Investors this year will need to decide how augmented terms will affect their bottom line in considering Fund Appreciation Rights funds (FARs), Segregated Portfolio Company (SPC) or managed account arrangements.
Utah again is understood to be leading this effort too (see page 12), in that the retirement system is thought to be considering a FARs fund structure that is based on the concept of multi-year exposure that will mean investors do not pay incentive compensation at a rate greater than initially agreed upon. The term structure carries a clawback provision that says at the end of the performance time period an investor actually cashes in their FARs stock options and the manager is then paid an incentive fee.
The concept of a FARs fund also relies on adoption from a fair number of managers as there is some uncertainty over whether it accords with the tax code in the US.
SPC measures are another way to use FARs for compensation. This structure is seeking buy-in from investors in that it offers an individual portfolio or series of 'cell' portfolios and managers are compensated via a FARs arrangement. Critics of SPCs say they are an untested concept legally as most investors wouldn't want their portfolio or cell to be penetrated by the liabilities of other cells.
In the meantime, larger investors are also setting up managed account structures in the interest of better control of assets. Only time will tell though if the fee structure of managed accounts is worth the added benefits of liquidity and transparency. UCITS III funds are gaining momentum in Europe as well.
The final goal of the mainly US hockey match may be made by the hedge fund managers, but whether the final score is 2-1 in favour of investors, or tied at 2-2, will be determined this year. A long-term standoff is not an option as the opportunity lost for both investors and managers is too great if no attempts are made to control the puck.