The last decade has seen extreme fee pressure on traditional hedge funds, especially as liquid alternatives have grown, providing not only more liquidity and transparency, but typically lower fees. The standard 2 & 20 (2% management fee and 20% incentive fee) has come down for many funds. However, many investors may not be aware of so called pass-through fees, recently highlighted in a Business Insider article.
These are fees above and beyond the management and incentive fees, and are used for firm expenses such as trader bonuses, technology, travel and even the development of intellectual property. On the extreme end, these fees can account for 5-10% of assets. It is amazing to us that these types of expenses are still pushed on investors, given that a 2016 survey by consulting firm EY (formerly Ernst & Young) found that 95% of investors prefer no pass-through expenses (surprise, surprise).
This whole situation has come to light due to unusually low performance by many top hedge funds. However, we’re not as concerned with the expenses themselves as we are in the lack of transparency around them, as net returns do reflect all costs at the end of the day. While supporters of the fees say they are necessary to keep elite talent and maintain top technology, our argument is that if true, hedge funds should simply charge higher management and incentive fees, and then defend those fees in the market place.
Hiding such fees as a line item in a fund’s annual audit (click here to see a historical example) seems a bit cowardly. Of course, investors in hedge fund-like mutual funds don’t have to worry about such fees. Just something to think about as you make changes to your portfolio in the coming year.