Hedge fund investors calling for set rate of return

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Major hedge fund investors including New Jersey’s pension and the Orange County Employees Retirement System, are asking that a set rate of return is committed to before the hedge funds earn incentive fees in a bid to tackle the sting of underperformance.

In a bid to stop the issue of underperformance, hedge funds are agreeing to commit to the so-called 'hurdle rates.' While some funds have 'hard hurdles,' which means that they must generate between four and 10 per cent return prior to them being paid, others must make a set amount above the Libor or cash, it was confirmed.

Kelsey Deshler, a portfolio manager at Credit Suisse Asset Management, told the Financial Times: "This is here to stay, and in fact it’s going to become more the norm to have these more creative relationships on the fee side."

Many funds, including equity funds Viking, Maverick and Tybourne, already make use of these hurdles in order to ensure that their investors do not feel they are paying for little more than the hedge fund tracking the market on their behalf. With hurdle rates such as the ones employed by these firms becoming increasingly popular in recent years, hedge fund managers are beginning to see a shift in power as investors move to the top of the list. Indeed, while managers are able to make huge fees when their funds are performing well, investors are able to withdraw vast sums of money during times of poor performance, giving them the overall power.

Over the first six months of this year, hedge fund investors have removed $28 billion worth of investment from the market, eVestment data confirmed, mainly due to the turbulent economic climate. Related research from Barclays suggested that the number of hedge funds will likely decrease over the course of this year, with liquidations increasing by a worrying 12 per cent, far higher than the traditional average of around 10 per cent. Fewer funds will also be able to star up, the research confirmed.

According to Emma Bewley, Connection Capital’s head of fund investment, these hurdles are more transparent in closed-end structures that come complete with a time limit. She told the Financial Times: "You have to strike a balance between paying appropriate performance while not pushing a manager to take excessive risk to beat the hurdle.”

While hedge funds are currently not enjoying the best of health, thanks to years of mercurial performance tainting investor attitude, things may be looking up. Indeed, the funds generated positive returns for the five consecutive months until July of this year, clocking up returns of 3.7 per cent so far for 2016, according to a recent Preqin index.

Also, as the buyout sector heads towards a time in which it will no longer offer a preferred return of eight per cent on funds prior to managers taking a profit share, hedge funds are moving towards adopting that measure. Many industry insiders believe that this adoption could prove positive for hedge fund from an investor attitude point of view and, with start-up hedge funds increasingly turning to this practice, the sector could be heading for a stronger 2017.

One industry insider told the Financial Times: "Unlike PE funds that raise new funds every few years and negotiate the terms of those funds with large investors, hedge funds have been very boilerplate ‘take it or leave it’. Hopefully that will change as it gets harder and harder to raise capital.”

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