Hedge funds are starting to lower the fees they charge investors. For years, fees in the industry were pretty standard at 2% of assets and 20% of investment profits, but those fees are now in danger.
Over the last couple of years fees have come down, to a point where hedge funds are currently charging 1.6% of assets and claiming 18% of investment gains. While the drop is not huge, the monetary impact is, and I believe that fees could be headed even lower now that the Securities and Exchange Commission has voted in favor of letting hedge funds advertise.
To get a better understanding of how much money is at play here, consider that the hedge fund industry manages around $2.41 trillion. Last year, the fees that were collected based on assets under management and performance totaled $50.5 billion, according to industry tracker HFR.
The pressure for lower fees began to mount following the recent recession, when hedge funds stopped producing returns that investors felt were fair for the large fees that they were being charged.
While performance has been the primary reason for hedge-fund managers to cut back on their fees, going forward we may see fees come down as a result of funds being allowed to solicit new investors.
The idea of allowing private issuers to begin soliciting investors through advertising has been on the minds of hedge funds since the change was recommended in last year's JOBS Act. Earlier this summer the SEC voted 4 to 1 in favor of the recommendation, which allows hedge funds to advertise and discuss investment opportunities, as well as publicize past performance.
As these funds begin to advertise, they are going to want to show potential investors the lowest fees possible. It is highly unlikely that hedge funds will make public ads discussing strategies, and performance has not been so hot lately, so that basically just leaves fees as a way to differentiate between different funds.
With so much money in the hedge-fund market, funds are going to be as aggressive as possible to attract new accounts, and the best way they can accomplish this is by advertising the lowest fees possible. Advertising should have a major impact on fees. I can foresee a race to be the lowest cost hedge fund, and while the vast majority of funds will continue to charge higher fees, they are going to be forced to at least lower what they are currently charging or face big losses in their investor counts.
It will be similar to the way all the major brokerages were forced to lower commissions after services like E-Trade (ETFC) and Scottrade hit the scene with their super-low commission structures.
Fees are already coming down, and poor performance and increased advertising will lead to even further reductions in the years ahead.
Julian Close has been a professional business writer since the first day of the twenty-first century, having written for PRA International and the United Nations Department of Peacekeeping. He graduated from Davidson College in 1993 and received a Masters of Arts in Teaching from Mary Baldwin College in 2011. He became a stockbroker in 1993, but now works for Fresh Brewed Media and uses his powers only for good. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.