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August 15, 2018  

LPs: "More to Be Done" on Lowering Fees

After 10 years of pressuring fund operators to reduce fees, most institutional investors are dissatisfied with the lack of progress.

Six out of 10 investors surveyed by Morgan Stanley’s prime-brokerage group said the majority of the managers in their portfolios haven’t lowered their fees, with some saying the industry “has yet to shift significantly.” Another 33% of investors said most managers have trimmed fees but there’s “still more to be done.” A mere 7% said they’re satisfied with the progress made since institutional investors began questioning managers about the traditional “2-and-20” fee structure in the aftermath of the 2008 market crash.

“Investors believe we’re likely in the third to fifth inning in fee reductions,” Morgan Stanley commented.

The survey, conducted in the second quarter, captured the views of some 200 institutions with a combined $650 billion of hedge fund assets — or about 20% of the industry’s total assets under management. A third of the respondents were family offices, followed by funds of funds, endowments, foundations, consultants and pensions.

To be sure, hedge fund fees have come down since the financial crisis. A separate survey that Deutsche Bank’s prime-brokerage division published earlier this year found management fees had declined to an average of 1.56%, from about 2%, while performance fees had dropped to 17.3%, from about 20%.

Ongoing pressure to lower fees is “just life now,” once source said. “Your job as an investor is getting a better fee in addition to getting a good investment.”

Aside from demanding lower fees, investors increasingly are asking managers to consider other ways to better align their interests. Asked by Morgan Stanley about the best ways to harmonize the goals of managers and investors, the highest number of survey respondents (18%) cited hurdle rates, followed by scaling fees downward as assets under management rise (10%). Smaller numbers of investors cited clawback provisions and the “1-or-30” fee structure espoused by Texas Teachers and consultant Albourne.

Notwithstanding their feelings about fees, investors are generally more bullish about hedge funds than they have been in a few years. “Despite the continued market volatility, investor sentiment increased quarter over quarter to its highest level since heading into the first quarter of 2016,” Morgan Stanley’s survey found.

Among the biggest beneficiaries are long/short equity funds, which saw net inflows in the second quarter for the first time in 11 quarters. And more than 50% of investors surveyed said they plan to take new positions in long/short equity funds or add to existing positions during the second half.