Hedge fund investors, impatient with disappointing performance, high fees and redemption roadblocks, aren’t
waiting for Congress to legislate some type of federal oversight. Hedge fund managers, including superstars that previously seemed invulnerable to market pressures, are seeing power shift toward investors, who are seeking to exercise greater oversight as they move to protect their interests in a climate of ongoing market turmoil.
Such a shift, by
providing pressure to reduce fees, increase transparency and stress operational due diligence, would be a clear plus for investors, and could also be a positive for the industry, by providing greater alignment of interests between investors and hedge fund managers. It could also take some pressure off understaffed and overworked agencies like the Securities and Exchange Commission by forcing the industry to begin making changes on its own that would otherwise require action by Congress and federal regulators.
A central focus of this power shift is performance fees. As recently as 2007, as investors clamored to get into hot hedge funds, fees of “two and 20” were the norm—two percent of assets and 20 percent of profits. In some cases, fees reached three percent of assets and 30 percent of profits, and more.
However, “strategies that could have been sold to investors in a hedge fund format just six months ago may be non-starters today,” says David Goldstein, a partner at law firm
White & Case in New York and co-head of the firm’s investment funds practice. “More and more investors are arguing that they do not want performance fees paid on unrealized gains. Key questions asked today include how to get money out of ‘gated’ funds and how to manage high water marks so that the manager doesn’t go out of business.”
Hedge fund performance plunged an average of 18. 3 percent last
year. Over 1,400 funds were forced to liquidate, and the carnage is far from over.
Faced with continuing turmoil —as well as growing fraud issues— Congress is under pressure to enact some form of regulation. On the House side, the bill favored by the industry, the Hedge Fund Adviser Registration Act of 2009, is similar to a previous effort at regulation in that it focuses on the hedge fund adviser as opposed to the fund itself. A Senate bill, the Hedge Fund Transparency Act, focuses on the regulation of the fund entity rather than the adviser, and would require the disclosure of a wide variety of previously confidential information.
But even as Congress debates, “Investors are demanding—and receiving—greater transparency and disclosure,” said Todd Groome, chair-
man of the Alternative Investment Management Assn., a global trade association, at a May 7 hearing held by the House subcommittee on capital markets. Groome added that this is resulting in lower fee levels, and changing the mix between base fees and performance fees.
Investor activism is also impacting operations and the back office. Groome said that institutional investors are demanding and receiving increased third-party services, such as independent administration, including verification as well as independent custody. Also, as Goldstein points out, lower fees are causing some hedge funds to scale back operations.
Dr. Susan Mangiero, president of Pension Governance Inc., a consulting firm in Trumbull, Conn., points out that Calpers, the California pension fund that is a big investor in hedge funds, sent a memo in March to 26 hedge funds and nine funds of funds that do business with Calpers, demanding better terms from the funds, including clawbacks of fees under certain conditions. Pension funds are also making similar demands of private equity funds, Mangiero said.
Meanwhile, says Goldstein, “Managers are adjusting to the new reality and lowering their expectations—for some of them, providing a stitch of humility. People who seemed impervious to reality are getting a taste of it. Traditionally, power was with the general partner of the fund. Now, people are not talking about whether power will shift but, as is asked in so many contexts now, when will it stop?” ■
VOLUME 21, NUMBER 11
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