From Low Rates to Low Fees

Since the financial crisis, the Federal Reserve has kept interest rates at historic lows. During the same period, hedge fund fees slipped below the infamous 2% for management/20% for performance mark.

This downward movement in fees is attributed to investor resistance and disappointing hedge fund returns—as in 2013. It turns out, there is also a connection to low interest rates.

If you consider the matter from the expense angle, the cost of fund borrowing, like all interest, is now far less than it used to be. Funds borrow money for various reasons, for instance to take advantage of investment opportunities or pay redeeming clients without having to sell assets.

Interest cost is usually passed on to investors, one way or the other. These days, for a fund that borrows to a significant extent, interest payments can account for around fifty basis points of the expense ratio. In the past, that number may have been closer to 100 basis points.

If the management fee includes interest, it can be reduced in tandem with the interest, without the manager making less. On the other had, some investors want a full accounting where fees, interest and other costs are each shown separately, to argue for lower fees in addition to lower interest payment. But not all managers provide a detailed breakdown of the expense ratio.

Interest costs have become part of the broader bargain by which clients – especially pensions and other institutions – seek to reduce their expenses. Another issue is early withdrawal fees, which differ widely across funds and strategies from as little as 1% of the assets to as much as 5% and higher.

The downward pressure on fees and other costs has been strong for several years and is expected to continue. Even well-established firms like the big quant shop D.E. Shaw agreed to manage money at lower cost.

At the same time, interest rates remain at record lows even as the Fed slowly tapers quantitative easing—AKA money printing. Large investors may succeed in reducing their costs both through less interest and lower fees, but not all managers agree. There are funds that still charge 2/20 or higher.


Tags: ,

Leave a Reply

Please log in using one of these methods to post your comment: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: