The Myth of 2 and 20
Why your assumptions about hedge fund fees are all wrong.
December 9, 2010
This blog represents a pet peeve of mine — the perceived level of hedge fund fees. My frustration has boiled over several times recently. First, Shirley Won, a writer for The Globe and Mail, in two articles she authored on hedge funds referred to the standard 2 and 20 fee that hedge funds charge. I actually wrote a response to her first missive, pointing out the error of that reference. Not only did she not respond (I really wasn’t expecting her to), but in the next article she wrote three weeks later, she again made the same reference to the normalcy of 2 and 20 as the hedge fund fee standard.
But it is worse than this. In October I attended the sold out Global ARC 2010 hedge fund conference in Boston. Stephen Harper was moderating a panel (no, not the Canadian Prime Minister but the talented CEO of Strathmore Asset Management, a Europe-centric fund of funds operating out of London, UK). During his session he made several references to the standard 2 and 20 fee that hedge funds charge. At the break after his session I challenged him on this assertion. After all if a fund of funds manager says it is the standard, it must be so, n’est-ce pas?
Finally, at a recent conference in London, UK, (reported in Opalesque) there was a session on hedge fund fees at which two senior fund of funds operators were commentators. They too had the working assumption that the standard hedge fund fee is 2 and 20.
Obviously I am going to disagree with this broadly held assumption. What I find so frustrating is that members of the hedge fund industry themselves believe this, thereby contributing to the myth and in the process creating an issue for the industry!
Ok, so what is the truth here? In showing the actual fees for hedge funds I am relying on two surveys conducted by well known firms in the business-Preqin and TrimTabs.
Preqin observes in its April 2010 report, “Management fees for single manager funds are, on average, considerably lower than the perceived industry standard of 2%. The mean management fee is 1.65% with the median at 1.5%.” (see chart below)
The TrimTabs Report — Hedge Fund Flows dated January 2009, shows the time progression of hedge fund fees (see chart below). Only about 35% of single manager funds have a 2% management fee. Certainly the movement has been upward until very recently. Many managers’ fees are in the 1-2% range. And of the managers that charge 2% or more, it has been my experience that this group is very over-weighted with CTAs (managed futures). Indeed, I do not know a CTA that charges under 2%, though I am sure some exist.
So I will make this noble supposition. Given that CTAs represent approximately 15% to 20% of the hedge fund industry and if we remove them from the sample, we can see that the rest of the industry has considerably lower management fees than 2%.
Finally, the data we are looking at represents managers’ posted fees. Any institutional investor with an allocation over $50 million can in most instances easily negotiate a fee discounted from the posted rate.
Two and 20 is not the standard!
(Click on charts to enlarge):