Hedge Funds Struggle

The hedge-fund industry may be on track to deliver its best annual returns in years, but many managers still aren't in a position to collect performance fees.

Most hedge-fund fortunes were earned through the collection of performance fees, typically 20% of any profit. The fee structure gives managers an incentive to outperform and provides some protection for their investors. But in the third quarter, roughly two-thirds of funds globally still hadn't recovered from the steep declines of 2008, estimates Chicago data tracker Hedge Fund Research Inc., or HFR. About a quarter of funds were more than 20% below their previous high point, or high-water mark, and thus couldn't charge performance fees for this year's gains.

Clawing back to the point at which a fund can charge such fees again requires having a percentage increase that is larger than past percentage losses. A client with $1 million at a fund that falls 50% would be left with a balance of $500,000, so the fund would have to rise 100% before the manager could start charging incentive fees again. Hedge funds as a group were up about 17% on average this year through the end of October, following losses of roughly 19%, according to HFR.

The industry “is recovering, but not yet recovered,” said Kenneth Heinz, HFR's president.

London hedge fund GLG PartnersLLP, whose shares are traded in U.S., says its funds posted returns of about 25% on average in the first nine months of this year but about $7.6 billion of assets remain below their high-water marks. That is more than half of the $14.1 billion of assets at the firm that are eligible for performance fees. Of that, about $3.9 billion is more than 30% below. That has helped trigger a 72% drop in performance fees for the three months ended September, to $1.9 million from $6.8 million a year earlier, according to GLG.

Co-Chief Executive Noam Gottesman, on a Nov. 5 call with analysts, said “the outlook for performance fees at GLG has brightened significantly with our strong investment performance over the course of 2009.” In total, GLG manages $21.6 billion of assets, including in mutual funds as well as hedge funds.

Regardless of performance, hedge funds also earn fees based on the amount of money they manage, typically 2% of funds under management. But those fees have been hurt by the marked decline in assets. The industry's assets stand at about $1.5 trillion, down from the peak of more than $1.9 trillion reached in early 2008.

The flagship fund at CQS LLP, another London fund, remains below its high-water mark despite being up about 26% this year through the end of October, according to a person familiar with the returns. The convertible-bond-focused fund posted losses of about 32% last year.

CQS's other funds, which each are up about 20% or more this year, have either regained their high-water marks or were never below, this person said. The best performer, the CQS Directional Opportunities Fund, was up an estimated 48% in the first 10 months of this year. CQS manages about $6.4 billion of assets in total.

For many managers, 2009 will be the second year in a row that they won't be pocketing performance fees. A lack of incentives can cause traders and other staff to jump ship, though there aren't as many places to jump to these days, as few hedge funds or bank proprietary trading desks are hiring. It also can create incentives for managers to shutter their funds and start new ones where they have the opportunity to earn performance fees right away–if they can attract investors.

The Children's Investment Fund Management LLP known as TCI, has had several senior executives leave, including co-founder Patrick Degorce, who departed at the end of last year and is setting up his own fund. The London fund, which ended last year down more than 40% after years of stellar returns, is up slightly this year, according to people familiar with the results. Some people were asked to leave TCI on performance grounds and several new hires have been made, one of these people said.

Source:  WSJ