Hedge Fund Investors Question Why They Should Pay for “Skill-less Returns”
A group of institutional investors, led by the Teacher Retirement System of Texas, has published an open letter to the hedge fund industry, urging managers to implement cash hurdles, which must be met before management fees are collected.
In a letter titled Regarding the Usage of Cash Hurdles in Incentive Fee Arrangements, a group of allocators questioned why they should be expected to pay “significant incentive fees” for “skill-less returns” that could be “easily obtainable” for free in today’s higher interest rate environment.
“We believe incentive payments on true value-add fixes a misalignment that has been present in fee structures throughout the maturation of the hedge fund industry,” the letter stated.
The investor group proposes that hedge funds only charge fees on returns that outperform the market, by adopting a “cash hurdles” model in which they get compensated for providing higher returns than “risk-free” investments.
“In 2023, a $1 billion market neutral hedge fund could have earned about $52 million (5.25%) returns just by holding cash, and if that fund charged a 20% incentive fee on absolute returns, would have taken home $10.5 million in compensation for taking zero risk,” the open letter stated.
“This is not sustainable, especially as it seems the risk-free rate may remain elevated for the foreseeable future; and it is not what LPs are asking GPs to do. “Earning cash returns is not the reason institutional LPs invest in hedge funds.”
The letter was signed by 29 allocators including pension funds, corporate defined benefit pension funds, endowments, sovereign wealth funds and foundations, as well as investment consultant firms Aksia, Albourne and Verus.
Signatories of the letter included the Texas Permanent School Fund, Canadian pension fund CDPQ, Singapore’s GIC, Korea Investment Management, UTIMCO, PERA of New Mexico, among others. The letter was also signed by investment consultant firms Aksia, Albourne and Verus.
Hedge funds returned 4.9% in the first quarter, according to data from Aurum. While the asset class outperformed bonds, which returned –2.1%, they underperformed equities, which returned 7.3% during the same period.