Hedge Funds With Highest Performance Fees Deliver Best Net Returns - Preqin

Stephen Little

30 August 2013

Hedge funds that charge performance fees of more than 20 per cent have produced the highest net returns in four out of the past six years, according to a new study by research firm .

The data revealed that hedge funds with at least a three-year track record that have posted positive returns each month since inception charge an average performance fee of 19.5 per cent.

In contrast, funds with positive performance in less than a quarter of the months studied charge an average performance fee of 16.67 per cent.

Preqin’s data shows that hedge funds which charge the highest performance fees also deliver the best long-term net absolute returns and produced the highest net returns for investors on a three-and five-year annual basis charge.

Funds with fees over 20 per cent have also produced the strongest risk adjusted net returns with a Sharpe ratio (2 per cent) of 2.11 over a three-year period, compared to 1.18 for funds with a performance fee of 20 per cent.

However, despite higher returns, Preqin said investors are still seeking further alignment of interests and are continuing to negotiate fees.

The proportion of investors that believe fund manager and investor interests are properly aligned has fallen from 74 per cent in 2012 to 64 per cent now.

Preqin said that management and performance fees were most commonly cited by investors as the area where improvements are necessary, with 55 per cent of investors seeking reductions in both.

The percentage of investors that have seen improvements in charges over the past 12 months is 68 per cent for management fees and 58 per cent for performance fees.

Meanwhile, 57 per cent of investors are now looking to negotiate fund terms and conditions, an increase from 46 per cent in 2012. Of those investors that tried to strike a new deal, 81 per cent were successful.

According to the data, investors are not only unhappy with negotiations, they are also not satisfied with how performance fees are charged.

The data showed that 49 per cent of investors are seeking managers to change how performance fees are charged and one way of doing this is through hurdle rates.

Funds with the highest fees are more likely to apply hurdle rates, when the performance fee is only paid on the fund's performance in excess of a benchmark rate or a fixed percentage.

More than two thirds (68 per cent) of funds that charge fees in excess of 20 per cent use hurdle rates, compared to just over half (51 per cent) of funds that charge less than 20 per cent.

"The funds with the highest performance fees have been the best at producing consistent long-term absolute net returns for their investors. This suggests investors are satisfied to pay higher compensations to those managers that have produced strong performance. The funds with the highest fees have also been shown to offer other concessions to investor demands, for instance by showing greater use of hurdle rates which must be met before performance incentives are charged," said Amy Bensted, head of hedge fund products at Preqin.