The Traditional "2 & 20" Fee Structure Is Taking A Hit As Hedge Funds Continue To Underperform
By Tyler Durden
Nearly a decade ago, Warren Buffett bet Protege Partners, a fund of hedge funds, that over the course of 10 years the S&P would outperform Protege’s returns net of all fees, costs and expenses. To make it real, the loser agreed to pay $1 million to the charity of the winner’s choice.
At this past year’s annual meeting, Warren Buffett provided an update on the now 8-year-old bet and, sure enough, the S&P has obliterated Protege’s net returns by over 40%, on a cumulative basis.
Buffett referred to the bet as the “most important investment lesson in the world.”
“I believe this is the most important investment lesson in the world.”
“[Losing by 40 points] may sound like a terrible result for the hedge funds, but it’s not a terrible result for the hedge fund managers. If you have a couple percentage points sliced off every year, that is a lot of money … It’s a compensation scheme that is unbelievable to me and that’s one reason I made this bet.”
“It’s so obvious and yet all the commercial push is telling you you ought to do something different today than you did yesterday. You don’t have to do that. You just have to sit back and let American industry go to shop for you.”
“No consultant in the world is going to tell you just buy an S&P index fund and sit for the next 50 years. You don’t get to be a consultant that way and you certainly don’t get an annual fee that way.”
Perhaps this simple example helps explain why many of the largest pension funds and endowments are pulling back on investments in hedge funds and seeking fees cuts from managers that they choose to keep in their portfolio. As the Financial Times points out, the days of the “2 & 20” hedge fund fee structure seem to be coming to an end.
“There’s a lot of creativity going on and an effort to find fee structures that work for both the manager and the investor,” says Ermanno Dal Pont, global head of strategic consulting at Barclays. “The days where everyone was on 2 and 20 and quarterly liquidity are surely over.”
Managers are offering discounts by using a scale of fees based on assets under management or time spent invested, so when assets rise or a certain amount of time passes, the early investors pay less, according to Barclays’ prime services group.
There are also longer performance fee crystallisation periods for funds with longer investment time horizons, and hurdles that place a threshold on incentive fees.
Some are also charging different levels of performance fees based on how big a return they made; granting discounts where existing investors can add more capital to a strategy during a down period at a reduced rate, and offering reduced fees if investors agree to lock up their capital for longer or invest a larger chunk of money.
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Source: The Traditional "2 & 20" Fee Structure Is Taking A Hit As Hedge Funds Continue To Underperform
