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May 04, 2016  

Investors Press Managers on Hurdle Rates

With hedge fund returns languishing, investors are asking managers for higher hurdle rates.

The $4 billion Philadelphia Board of Pensions is among those leading the charge. Sources also have pointed to Pacific Alternative Asset Management and Vanderbilt University’s endowment as engaging in such negotiations.

A hurdle rate sets the minimum return a fund operator must produce before it collects an incentive fee — typically 200 bp over Libor, or about 2.4%, for those employing such terms. But Philadelphia Board of Pensions is pushing for its managers to set bogeys as high as 7.75%.

“We are actively negotiating fees, structures and hurdle rates, and where appropriate, will seek to set a hurdle rate at or near the actuarial assumed rate of return,” said Christopher DiFusco, chief compliance officer for the Philadelphia pension.

For many fund operators, a hurdle rate would be something new. Indeed, only about 10% of the 4,738 active hedge funds in eVestment’s database offer such terms, with BarclayHedge pegging the number at about 20% of 5,190 vehicles.

The negotiations over hurdle rates encompass both existing commitments and new ones. The pressure on managers marks the continuation of a trend that began after the 2007-2008 market collapse, when investors responded to losses on their hedge fund positions by campaigning for lower management and incentive fees. Now, they believe a more recent performance lag is giving them bargaining power when it comes to winning concessions on manager compensation.

The Barclay Hedge Fund Index, compiled by BarclayHedge, was up a mere 1% for the first four months of this year.

Meanwhile, limited partners continue to push for lower management and performance fees. They include Philadelphia Board of Pensions, which has $350 million invested in hedge funds on behalf of city employees. Duke University’s $7.3 billion endowment also has been talking to one operator — described as running an Asia-focused vehicle — about an arrangement in which it would pay discounted fees equal to 0.5% of assets and 10% of profits on a potential commitment of $50 million to $100 million.

Even funds with strong performance aren’t immune. Case in point: Sources pointed to an undisclosed public pension system that wants one of its existing managers to cut its fees to 1% of assets and 10% of gains, from the standard 2% and 20%, despite solid returns.

In another example of how the balance of power is shifting in favor of limited partners, one marketer lamented a situation in which the former head of hedge fund investing for a large state pension has been scouting positions for a fund of funds he now runs — and is seeking the same terms he received at his former employer, despite having less capital to commit. “It’s becoming much more of a buyer’s market, even for the largest hedge funds out there,” the marketer said.