Fund of Funds Investing: A Roadmap to Portfolio Diversification

Chapter 9. Fees

One of the most contentious issues in the hedge fund and fund of funds industry is fees. According to PerTrac Financial Solutions LLP, a New York–based software company that aggregates hedge fund data and provides analytic tools for asset allocation, the average hedge fund charges a management fee of 1.50 percent and an incentive fee of 20 percent.

INCENTIVE FEE

Before the mid- to late-1970s, most managers that operated hedge funds charged just an incentive fee. This meant that if they made money for their clients, only then would the manager get paid. It also meant that if the manager lost money or the portfolio was flat, the manager had earned nothing. The interests of both parties were aligned. This alignment of interests is what A. W. Jones had in mind when he launched his fund in 1949, with just an incentive fee. The change came as fund complexes grew, overhead grew, and the management firms needed additional capital to operate their businesses.

The fee structure during most of the 1980s and the 1990s consisted of a 1 percent management fee and a 20 percent incentive fee. As the market grew and investor appetite for products grew, the fees increased; over time, they have settled into 1.5 and 20 percent. However, in light of the market dislocation of 2007, 2008, and 2009, don't be surprised if fees change again—this time, however, on the downside. In order to maintain assets and attract assets, some fund managers have lowered their fees and changed liquidity terms. ...