Why 2-and-20 is Here to Stay

So here’s the weird thing about that

Citigroup survey

of pension-fund managers. Apparently the notorious 2-and-20 fee structure is

doomed, even though the fund managers are going to increase their allocation

to alternative investments:

Almost 60% of managers surveyed indicated that the 2/20 fee structure was

unsustainable for private equity firms and almost 80% indicated that the fee

structure was unsustainable for hedge funds. Having said that, almost 70%

of US managers indicated that they are willing to pay the typical fee structure

if the alternative manager’s performance warrants…

About 85% of pension managers will increase their allocation to alternatives

over the next 3 years. Additionally, the alternative asset allocation within

pension funds will approach 20% (vs. 14% currently) over that same time period.

The actual expected increase in alternative investments is 35%: from 14.4%

of funds under management to 19.4%. So why on earth do 91% of European pension

fund managers think that the 2-and-20 structure for hedge funds won’t last another

five years? It’s lasted much more than that even as the number of hedge funds

has exploded. Now that the inevitable consolidation is beginning in the hedge-fund

industry, I see absolutely no reason to believe that anybody is going to move

away from 2-and-20 any time soon.

But what about Mohamed El-Erian’s move to Pimco, where he’s going to beef up

the west coast giant’s presently nonexistent alternative-investments arm? Surely

he won’t be charging 2-and-20?

No, he won’t, but (a) he will be investing in other hedge funds which do

charge 2-and-20 (at least to non-Pimco clients); and (b) he’s Pimco, and Pimco

tends to be an exception to many rules.

For the time being, the most successful hedge funds continue to be those which

charge more than 2-and-20, not less. So long as fees are perceived

to be a sign of ability, no one’s going to start discounting.

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