Agecroft Reflections: Fee Structures, Benefits of Emerging Managers within Hedge Fund Portfolios

Partnering with emerging managers and the associated benefits created a buzz among attendees at Agecroft’s Hedge Fund Investor Leadership Summit held in New York November 2-3. Here are some insights from conference attendees on fee expectations coupled with alignment, and the advantages of having emerging managers within the hedge fund portfolio (Note: Various participants define “emerging manager” differently, including by assets under management (AUM), track record, etc.).

Fee Structures

“Within the context of a 15-20% return, paying two and twenty [fee structure] does not seem unreasonable. Things have very much changed now, and [managers] are lucky to return 6-8%. Paying two and twenty or anything near that is [unrealistic]. The model where the manager is willing to bet on themselves is much more realistic, because before the manager was taking most of the economics…whereas in a true partnership, they’ll share the economics and we’re moving towards that.” –Robert Motoshige, director, PAAMCO

“We’ve come up with a fee structure that five out of the last six investments we’ve made the managers have adopted, called a one-ten-twenty structure. It’s very simple: a 1% management fee, 10% incentive fee, until the net return to the investor is 10%, then it jumps to 20% for full catch up. If you make teens rates of return, you’re fine; you’re getting a 20% incentive fee. …The quick bump from 10% to 20% creates an incentive for managers to reduce their expenses in the fund.” – Adil Abdulali, president & chief science officer, Protégé Partners & MOV37

“We often take a budget-based approach, where we often help emerging managers figure out what the budget is to run a business for the first few years and we’ll pay the management fee that allows them to run the business and then they get paid an incentive fee. Their budget can be a draw depending on the incentive fee, so they’re betting on themselves, which we’re more than happy to back.” –Timothy Berry, managing director, Lighthouse Partners

Benefits of Emerging Managers

“One of the pluses of investing with emerging managers is that they’re great partners, because you’re with them from the very beginning and so you can work together on a lot of things: how should you set up your compliance, your settlements or legal—things that traders certainly don’t think about, but that are important to run a business.” – Motoshige

 “[The emerging manager landscape is] arguably over-populated. It’s a lot harder to get funded. It’s a good thing and a bad thing.  It’s a great thing [as] we’ve had a lot of deal flow, a lot of opportunity. It does place a premium on uniqueness. It’s a very competitive business and puts the premium on finding a unique source of alpha.” –Bates Brown, head of hedge fund-of-funds, Maverick Capital

“Emerging managers are going to naturally have a higher ratio of going out of business in three to five years. On the other hand, if you have managers that are hungry that have less assets under management, that means higher alpha potential. We can negotiate better terms, meaning more of a true partnership. They’re more reasonable. The average hedge fund LP document is completely biased towards the hedge fund manager, the investor is highly restricted and the hedge fund can pretty much do whatever they want.” –Berry

 “Smaller hedge funds tend to outperform larger hedge funds. One of the problems with the hedge fund industry is that you have too much going to the largest managers. A number of larger managers are managing more money than their strategies can optimally handle, which means their alpha is being diluted over a larger asset base.” –Don Steinbrugge, CEO, Agecroft

“There’s always talent out there waiting to be discovered, so there’s a little more complexity right now, because there’s going to be more emerging managers outside the US.”- Susan Webb, founder, CEO and CIO, Appomattox Advisory

“The main benefit is that you [access] strategies when they aren’t already crowded.”- Abdulali

[Abdulali also emphasized the changing landscape presented by the rise of unstructured, nonfinancial data. Given this data cannot necessarily be analyzed by “traditional” analysts in the industry, but rather by data scientists or engineers, it has offered potential new opportunities/strategies within the hedge fund  space.]