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Hedge fund fees: investors should be wary of pass-through costs

Eat what you kill is a maxim followed by hedge funds. Some dine better than others, hiking their fees when performance is strong. The $11bn Caxton macro fund deserves a special mention for breaching “two and twenty” thresholds once cited as industry standards. It is raising its annual management fee to 2.25 per cent and its performance charge to 25 per cent.

Other hedgies have kept their gilt-edged plates overflowing by passing on expenses to investors. These so-called “pass-through costs” can reduce returns meaningfully. The success of some multi-manager platforms, such as Millennium and Citadel, has enabled them to command higher fee structures which include the pass-through costs. Among private capital managers the practice seems rife.

This runs counter to the historical trend. On average, management fees for hedge funds have fallen about 20 basis points to 1.36 per cent over the decade to June last year, according to Hedge Fund Research. Performance fees have contracted nearly as fast to 17 per cent.

Typical expenses charged to funds include broker commissions and custodian fees. But some managers foist a ragbag of extra operating costs on to their investors, including those for expensively-poached teams of traders sometimes lured by swanky new offices in comfortable climes such as Miami.

The most expensive multi-manager funds charge performance fees 20 percentage points above typical hedge funds partly because of added costs, according to a study by consultants Cambridge Associates. These pricier funds require 500 basis points of added gains to deliver a 10 per cent return net of fees.

Management fees often do not cover all costs, say the Alternative Investment Management Association. These can persistently total 30 to 50 basis points above fees, eating away at profits. It claims that only a minority of funds use pass-through costs.

With a paucity of top trading talent available, wage costs throughout the industry are soaring. More funds may well follow the pass-through route, raising the bar on required gross returns even higher — providing their performance holds up.

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