HONG KONG: The hedge fund industry’s shift away from the much-maligned 2-and-20 fee model is gathering steam in Asia.

As investors worldwide are balking at hefty fees, Hong Kong hedge funds Myriad Asset Management and Ortus Capital Management are crafting alternatives that mark a radical departure from the industry practice of charging 2 per cent of assets in management fees and 20 per cent of profits.

Myriad, which manages more than $4.1 billion (Dh15.06 billion), is adding a new share class in its hedge fund that charges the greater of a 30 per cent cut of profits or 1 per cent of assets under management to better align its interests with those of investors, said a person with knowledge of the matter. Ortus in July started a fund that takes a 33 per cent share of profits without charging any management fee, according to a newsletter to investors obtained by Bloomberg.

“Asia funds have typically and historically been slower at responding to changes in new or innovative fee or liquidity structures,” said Hugh Abdullah, Morgan Stanley’s head of hedge fund capital introductions for Asia. That’s changing as “they may face investor pressure or demand, have a desire to take a strategic direction for their business given where they foresee the industry is heading, or they may have a view on what ultimately is equitable.”

There’s been a widespread investor backlash against hedge funds after years of lacklustre returns. The HFRI Fund-Weighted Composite Index gained 5.5 per cent last year, trailing the 7 per cent to 8 per cent return targeted by most US pension funds — a major source of industry capital — for the third straight year. Investors pulled $106 billion out of the $3 trillion hedge fund industry last year, the largest annual outflows since 2009, according to data provider eVestment.

Globally, at least two dozen “well-known” managers with institutional investors have either adopted or are working on a so-called “1-or-30” fee model that was introduced to the industry in the fourth quarter, according to Jonathan Koerner of Albourne Partners, which advises clients on more than $400 billion of alternative investments globally. Global manager Brevan Howard Asset Management in September said it would stop charging management fees on new capital committed by existing clients to two of its funds.

“We have now behind us several years where returns for a lot of managers were below 8 per cent annualised. It has really brought to the light the inequity of the 2-and-20,” said Norwalk, Connecticut-based Koerner, whose responsibilities include helping clients negotiate fees. “The objective of 1-or-30 is to more consistently ensure that the investor retains 70 per cent of alpha generated for its investment in a hedge fund,” he said, referring to returns in excess of a market benchmark.

New model

The “1-or-30” model, championed by investors including the Teacher Retirement System of Texas, allows managers to take home the greater of a 1 per cent management fee or a 30 per cent cut of gains in excess of a benchmark, according to a December paper written by Albourne’s Koerner. The management fees charged during a year when the fund trails benchmarks is deducted from the following year’s performance fee payment, making it, in effect, a prepaid performance fee credit, he added in an email.

Koerner said he is aware of other investors, including non-Albourne clients, who are now demanding 1-or-30 from hedge funds.

The shift underway represents a marked change from the 2-and-20 model, which is a losing proposition for investors if hedge funds don’t make more money than the management fees they charge. Such fees have also been criticised for creating incentives for managers to expand assets instead of focusing on consistent returns for existing investors.

“A traditional management fee is paid regardless of fund performance, making it enemy number one to those investors with the goal of achieving a consistent total profit share with managers,” said Koerner.

A fund that takes 1.5 per cent cut of assets and 20 per cent of gains will have to make at least 8.7 per cent after fees to ensure investors get 70 per cent of the profits — a split that investors including Texas Teacher consider equitable, according to Koerner.

The $133 billion Texas fund, which had $10.6 billion of hedge fund investments, paid $203.5 million in management and performance fees directly or indirectly to them in the fiscal year to August, according to an annual financial report. Its directional hedge fund holdings had a “time-weighted” annualised return of 1.2 per cent over the last three years while its stable-value hedge fund holdings gained 4.2 per cent in the same period.

Myriad’s fees

Myriad, founded by former Highbridge Capital Management Asia head Carl Huttenlocher, is offering the new share class to all investors, while keeping all existing share classes. Unlike the model proposed by Texas Teachers and Albourne, the performance fee is charged on total return instead of outperformance relative to a benchmark, as it is difficult to work out a benchmark for any fund that uses multiple strategies, said the person, who asked not to be identified because the moves haven’t been publicly disclosed.

One of Asia’s largest hedge-fund managers, Myriad has generated an annualised return of 10.5 per cent after fees, making money every year since it opened the fund to investors in December 2011. Its after-fees return last year is estimated at about 4 per cent, said the person.

Ortus was founded in 2003 by Joe Zhou, a former proprietary trader at Lehman Brothers Holdings Inc. and Bear Stearns Cos. The $661 million manager uses computer models to trade global currencies. In addition to the Ortus Leveraged FX Fund, which charges no management fee, the firm also started the Ortus FX Fund in mid-August, which has a 1 per cent management fee and takes a 25 per cent cut of performance, according to the letter sent to investors.

Sam Guinness, an investor relations officer at Myriad, and Stewart Bent, Ortus’s head of business development and investor relations, declined to comment.

Investor pressure

Under investor pressure, industry-wide average management fees have declined to 1.6 per cent and performance fee to 19.3 per cent, according to a survey released by data provider Preqin in September. Still, 58 per cent of investors in the survey said their interests were not aligned with managers’, a number that had climbed from 49 per cent in June 2015.

The easiest way to ensure that investors consistently get 30 per cent of fund profits would be charging only a 30 per cent incentive fee and no management fee, like the Ortus fund.

Yet, that model could result in a “significant business risk” during any period of underperformance, according to Koerner.

Knight Assets & Co., a London-based investment firm last year raised about $300 million for a new stock-focused fund with no management fee. The fund, which had targeted gathering $500 million by early this year, it is instead being slowly wound down after Chief Investment Officer Akshay Naheta decided to join SoftBank Group Corp.

— Bloomberg