Hedge funds have long been synonymous with high fees, historically operating under the “two and 20” fee structure. This means investors pay a 2% annual management fee and a 20% performance fee on investment returns. However, over the years, the fee dynamics in the hedge fund industry have undergone significant shifts, with rising costs and evolving models creating new challenges and opportunities for investors.

The Rising Fee Burden

According to research by LCH, the share of gross gains consumed by management fees has risen dramatically. Two decades ago, management fees accounted for roughly 30% of gross gains. Today, they comprise about 50%. This trend reflects a stark departure from earlier decades; in the 1960s and 1970s, management fees represented less than 10% of gross gains.

This upward trajectory suggests that efforts by institutional investors and consultants to curb fees have largely failed. Instead, management fees have increased disproportionately as investment returns have generally declined, placing a heavier financial burden on investors.

The Rise of Multi-Manager Platforms

One of the most significant developments contributing to higher fees is the growth of multi-manager platforms. This segment has become the fastest-growing area within the hedge fund industry, as noted by prime brokers. Unlike traditional hedge funds, multi-manager platforms operate on a “pass-through” expenses model.

Under this model, managers pass all operating costs directly to investors instead of charging a fixed annual management fee. These costs can include office rent, technology and data expenses, salaries, bonuses, and even client entertainment. Typically, these expenses range from 3% to 10% of assets annually. In addition to these costs, investors are charged a performance fee of 20-30% of profits.

Implications for Investors

The evolution of fee structures in the hedge fund industry raises important considerations for investors. The shift toward higher management fees and pass-through expense models can erode returns, particularly in an environment of lower overall performance. While multi-manager platforms offer unique investment opportunities and diversified strategies, their cost structures require careful evaluation.

For investors, understanding the true cost of hedge fund investments is critical. Beyond headline fees, it’s essential to consider how fee structures align with performance and whether the value provided justifies the expense.

The hedge fund industry’s fee landscape is more complex than ever. As management fees continue to rise and new models like pass-through expenses gain prominence, investors must remain vigilant. Scrutinizing fees and ensuring they are proportionate to returns is essential to achieving long-term investment success in this evolving market.