Do hedge funds charge too much?

William

Hutchings of Financial News had a big piece on Friday examining the performance

of the most expensive hedge funds: places which blow away the standard 2-and-20

structure with structures like Citadel’s 8.75-and-20, GAM/Caxton’s 4.5-and-30,

or SAC’s eye-popping 0-and-50. Hutchings reckons those enormous fees aren’t

worth the money:

Most of the 20 funds surveyed that investors identified as expensive were

beaten last year by the equity market. Three had lost money for investors

in the first 11 months, though two, Quadriga and Denali Partners, pulled their

performance back into the black in December. Whitney, which had lost almost

32% of its Japan select fund in the first 11 months, declined to comment.

Some of the expensive funds have been generating single-digit net returns

for some time, according to investors.

Dealbook

picked up on an interestingly self-serving quote at the end of the piece:

Some investors are deterred by funds that charge fees below the standard

scale of 1.5% to 2% management fees and 20% performance fees.

A partner at a multi-billion hedge fund manager said some had declined to

invest in a new fund it launched because its fees were low: “They could

not take us seriously,” he said.

I don’t buy it: "They didn’t buy my product because it was too cheap"

is never particularly convincing, even when it’s true.

Alexander

Campbell is definitely in the same boat as William Hutchings:

Hedge fund returns have been falling for some time, and papers like this

one are just going to make more people ask the two questions that hedge fund

managers least like to hear: why, exactly, should I give you any of my money

to invest; and why, exactly, should you get to keep so much of it?

But I, contrarian that I am, am much more impressed with Christopher

Holt’s response to the Hutchings piece. Here’s the bit which really made

me sit up and take notice:

Like all participants in a market economy, hedge fund managers charge the

highest price they can. The result is an equilibrium between supply and demand

for which no one – not the manager nor the investor – is to blame.

The fact is that hedge funds are mostly size-constrained, and most of the biggest

and most famous ones are closed to new investors in any event. In that kind

of supply-constrained situation, it makes all the sense in the world for the

fees to rise, since with a standard 2-and-20 fee structure, all these famous

funds would be monstrously oversubscribed.

Hutchings and Campbell might stop to wonder when they start to sound like mutual-fund

reporters on the personal-finance beat. No hedge fund investor is asking them

for their advice on which hedge fund(s) to invest in, and, to reiterate, most

of the most expensive hedge funds are closed and therefore impossible to invest

in in any case. The only people who might care about the fees are the people

who are already invested in these funds – and those people tend to have

made so much money from the funds that one can forgive them for feeling a bit

smug in their seeming profligacy.

There’s a telling quote at the end of Hutchings’ story:

“It is not rational,” said a private banker. “Plenty of

high net worth individuals like to show off to each other their investments

in reputed hedge funds. They use the word ‘vintage’ to describe

the year in which they became an investor. It is just as though they have

bought a fine wine.”

Why isn’t that rational? If I bought into a now-famous hedge fund just before

it started a 10-year run of 40% annualized returns, I’d be pretty chuffed too.