Even ardent defenders of hedge fund fee structures must acknowledge the impact a marketplace open to retail investors may have on the status quo. Is the hedge fund 2 and 20 rule going the way of the banking industry’s 3-6-3 rule?
Disruption
It is no revelation that 2 and 20 has been under assault for some time. Average management fees have plummeted 25 percent and the average take on profits has dropped 10 percent, making the two and twenty rule a misnomer. More accurately, it has become the 1.5 and 18 rule.
The erosion of the hedge fund’s traditional fee structure is certainly a response to the lackluster performance of hedge funds relative to benchmark indices, specifically the S&P 500. While arguments can be made that using the S&P 500 as a performance benchmark is a questionable practice, the fact remains that hedge funds, particularly long-short hedge funds, have under-performed the S&P 500 consistently since December, 2010.
Understandably, investors of all stripes have rebelled against a hedge fund fee structure that does not reflect its underwhelming performance.
A Time for Every Purpose
Enter Convoy Investments, LLC, co-founded by Howard Wang and Robert Wu, formerly of Bridgewater Associates, LP.
Convoy has responded to investor concerns over the merits of the 2 and 20 fee structure by eliminating the 20 percent performance fee altogether and reducing the management fee to 1.25 percent. Additionally, the firm has reduced its minimum investment to $500,000 in sharp contrast to the standard required minimum of $1 million.
This will be attractive to a subset of disgruntled institutional investors and well-received by retail investors sitting on the sidelines because of the hefty fees typically associated with a hedge fund investment. Wu and Wang have introduced this novel fee structure at the confluence of an investor rebellion against 2 and 20 conventions, and the rise of the retail investor, easily put-off by what are perceived to be extraordinary fees for otherwise ordinary returns.
Is This the Trend?
Only time will tell if Convoy’s fee structure will divert assets from hedge funds operating on a more traditional fee structure. Like any hedge fund, Convoy’s track record will be the principal driver for investment. There is no fee low enough to attract an investor to an under-performing hedge fund. Convoy has yet to establish a track record but, Howard Wang and Robert Wu have earned their bona fides by virtue of their Bridgewater experience. Time will tell how much they learned from that experience and if it can be translated into returns that will grow the firm’s assets under management.
There are a number of ways hedge funds can differentiate themselves from one another and the fee structure may be the least significant methodology. Performance will always be the principal driver and experienced investors are keenly aware that there is no free lunch. Performance fees are a powerful incentive and the absence of such a fee may, at first blush, seem attractive, it may also be a harbinger of lackluster gains. How Convoy’s fee structure is received and, how it performs relative to its peers, will be an interesting story to watch unfold.
