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Digital Subscriptions > The Hedge Fund Journal > Issue 116 - September 2016 > AIMA Paper: In Concert Exploring the alignment of interests between hedge fund managers and investors

AIMA Paper: In Concert Exploring the alignment of interests between hedge fund managers and investors

EXTRACTS FROM AIMA’S PAPER: IN CONCERT SPONSORED BY RSM

Download the full paper from www.aima.org

EXECUTIVE SUMMARY

In this paper we investigate the methods that are being employed to align the interests of managers of hedge funds (‘managers’), and investors in hedge funds (‘investors’). Our findings are based on an extensive manager survey comprising 120 respondents with assets under management (AUM) of over $500bn. The respondents are varied in terms of strategic approach and size. AUMs range from below $100m to more than $20bn. We analyse the findings based not only on what is currently being done, but also in terms of potential future developments and how these could best be implemented.

We begin by investigating the measures which, if put in place, can reduce fees. We find that high water marks are extremely popular, with 97% of managers using the structure. Hurdle rates also prove to be commonly used (employed by one third of the managers) and, for fixed percentage thresholds, are usually in excess of 3% (60% of managers who have a target set it in excess of this benchmark). Indirectly, we discuss how investors can negotiate lower fees by accepting a longer lock-up period on their capital. We consider how this could further enhance returns by allowing the manager to execute his investment thesis more efficiently, without having to compromise performance by having to maintain cash buffers to offset potential redemption requests.

We then look at other features managers have employed to make their offering more attractive to potential investors. We think about transparency and observe how the disclosures made by managers have greatly increased since the global financial crisis of 2008. We also discuss the importance of managers having “skin in the game” or personal capital invested in their strategies. We find that 61% of managers currently use this as their primary means of aligning interests with their investors.

Our third section examines the varying fee structures that managers can employ. We look at the cost-push factors that led to the 2% management fee and 20% incentive fee (or as it is more colloquially called “2 & 20”) becoming the norm in the recent past and discuss the special types of share classes used to provide discounts to certain groups of investors.

We look particularly closely at tiered fee structures, where the fees paid reduce as the AUM of the fund grows. Almost 77% of hedge fund managers who participated in our research said they are considering implementation of this measure.

The final section seeks to demonstrate that, in achieving a closer and more aligned relationship, both managers and investors stand to benefit. We see the advantages as threefold. First, as the investor attains more knowledge about the manager they will gain a deeper understanding of how the fund will behave.

This will help to avoid short-termism which can damage performance. Second, the enhanced clarity of relationship enables the sharing of expertise which can benefit both parties: the manager because he will gain a better understanding of the client’s needs, and be able to cater to them more effectively, and the investor because they will be able to take advantage of the manager’s unique market insights to the betterment of their overall portfolio. Thirdly, closer collaboration enables new products and services − such as co-investments and managed accounts − to be developed which will give the investor a greater range of products to enhance their portfolio returns.

We conclude the paper by highlighting the flexibility of the tools that have been discussed. We assert that there is no one-size-fits-all when aligning investor and manager interests and that the different methods should be calibrated to the specifics of the individual situation. The aim should be to reach a point where manager and investor are incentivised to act in a way which is mutually beneficial, and that in doing this a relationship of symbiotic collaboration might develop.

DEMOGRAPHIC OF RESPONDENTS

Source: AIMA
Source: AIMA

METHODOLOGY

1. Hedge fund manager survey with input from 120 hedge fund managers globally representing approximately $500bn in assets under management (AUM);

2. In-depth one-on–one interviews with hedge fund managers to help get a better understanding of the key findings from the manager survey;

3. Input from a global investor steering committee which manages approximately $1 trillion AUM and allocates c.$100bn AUM to hedge funds;

4. Input from a variety of thought leadership and external research across a variety of hedge fund industry stakeholders including investors, hedge fund managers, hedge fund industry service providers and policy-makers

Source: AIMA

1 POPULAR FUND TOOLS THAT MANAGERS MAKE AVAILABLE TO INVESTORS TO HELP MODERATE THEIR FEES

It is evident that managers are responding to client’s needs by putting in place a number of tools that help ensure that their investment strategies are carried out as is intended, and fees are structured in a way so that the alpha capture is split appropriately between managers and investors. These measures are:

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