The conversation around hedge-fund fees is reaching a fever pitch. Blame the talent.

• Hedge funds, particularly multistrategy giants, have demanded more fees from their backers.
• These managers say the cost of running a complex fund is rising thanks to a limited amount of talent.
• With higher interest rates and muted performance, hedge-fund investors have pushed back.

Hedge fund investors big and small are once again hyperfocused on the industry's most contentious topic: fees.

In the decade or so leading up to the pandemic, the average hedge fund fees slowly declined, but this year was the first time the average fee rose in a decade. A BNP Paribas survey of 238 allocators from the start of 2024 stated that performance fees jumped to 17.8% this year compared with 16.9% in 2023, while management fees bumped up to 1.54% from 1.46%.

Like any industry, it was a function of supply and demand. Thanks to the stability many top multistrategy hedge funds displayed during the onset of the pandemic, LPs scrambled to get in. These sprawling managers, though, are the most expensive type of hedge fund, with much higher headcounts and more complicated systems than peers that focus solely on equity trading or macro investing.

These funds used this demand to lock investors into high-fee agreements, but as interest rates have risen without a corresponding bump in returns, many allocators are wondering what they're paying for. Hedge-fund allocator Aurum found that multistrategy funds were up, on average, 6.1% in the first half of 2024 — trailing the average quant-only fund and the S&P 500's return of 15% over the same period.

Some of the largest institutional investors, led by the $200 billion pension Teacher Retirement System of Texas, have gone so far as to publish an open letter to the industry, calling for managers to adopt a cash hurdle that would prevent them from receiving performance fees above what US treasury bonds would return.

The industry has "gone full circle" on fees, said Lilly Knight, cohead of investment management at Franklin Templeton's K2 Advisors, a $10.2 billion fund of hedge funds, and frustration is mounting.

K2, she said, "has gently walked away from a few multistrats, reduced our allocations."

LPs are paying not for performance but for the ongoing talent war, which has led to in-demand portfolio managers receiving eight-figure guaranteed payouts. While the structure of multistrategy firms — which combines teams trading different asset classes in many geographies to generate stable returns that are uncorrelated to the markets — is still beloved, the space has gotten so crowded that there's not enough talent to fill seats.

This shortage is pushing the industry to a breaking point.

People problems

Many funds hoping to keep or attract top talent have resorted to charging — on top of a management fee, a performance charge, and a pass-through expense — a fixed fee that creates a pool of money just for paying PMs, Knight said. This new structure, which Knight said many funds rolled out in the last 12 months, is a break from the traditional model.

Knight declined to name specific funds that have introduced this new charge, but known examples include managers such as London-based Marshall Wace, which introduced a 75-basis-point fee just for talent. While such measures seem extreme for some allocators, it's clear the industry's talent shortage isn't going away anytime soon. For example, in rebuilding its equities franchise, Balyasny has doled out more than $200 million, Bloomberg reported.

In the past, Knight said, the management fee was used to run the business, while the performance fee was used to "pay the people."

"Wasn't that enough?" she asked.

A fixed fee turns that notion on its head because it guarantees payouts to investors who might not end up making any money.

"You want people to be rewarded after the fact," she said.

Insulated at the top

Like most industries, top hedge funds like Millennium and Citadel are not feeling the heat as intensely on fees as the space's middle class.

There's still demand for the top tier of the industry, regardless of fees, according to James Ouderkirk, director of business development at GLASfunds, a $3 billion alternatives platform that works with advisors for the wealthy.

"They understand that the returns have been there" at those managers, Ouderkirk said.

"The fee pressures there are just not felt."

Currently, his platform recommends four different multistrategy options to its clients, including Morgan Stanley's Riverview Omni.

Lesser-known multi-managers and new launches, though, are getting pushback. Even with Bobby Jain's pedigree, his new firm launched in July with $5.3 billion — less than many thought he would raise. Three people said that if Jain Global had launched five years earlier, it would have matched the $8.6 billion haul Michael Gelband's ExodusPoint pulled in.

Some managers have found ways to keep talent costs down. Norias Research, from former Point72 president Doug Haynes, garnered interest from LPs because it didn't have a pass-through fee thanks to its quantamental structure. Systemic-trading funds such as CenterBook Partners pull investment data from dozens of partner funds that get a portion of the firm's performance fees but don't have to hire scores of individual PMs to get a diversified return stream.

At Acadian Asset Management, the Boston-based firm launched its multistrategy hedge fund 4.5 years ago with no gates, no lock-ups, and no pass-through fees. It offers monthly liquidity to its investors, according to Mike Gleason, the firm's director of equity alternative strategies.

The firm has been focused on keeping costs down for the strategy, Gleason said, and is very intentional about adding new strategies to the fund — never planning to exceed a dozen or so total.

"We are building them in a very purposeful way to fit them together," he said.

Being very particular about what strategies it adds helps the fund control costs by keeping its head count down — and not competing for the same talent as the largest managers.

"If you can control the costs, you can recapture some of that alpha," Gleason said.

Who should be paid

Fund-of-funds Corbin Capital isn't an investor in the biggest platforms in the world, partly because they're "so hard to evaluate," according to Craig Bergstrom, the firm's chief investment officer. But generally, he said, fees in the industry are too elevated for the current market reality.

Decades ago, at the start of the industry, the best hedge funds could truly outperform thanks to higher volatility and less competition. This isn't the case anymore, and a larger chunk of the fees paid are going to GP's business instead of its moneymakers.

"How rich do you need your hedge fund manager to be?" he asked.

Because he and others in the industry are happy to pay when performance comes along with it. He said some of his portfolio's best performers are firms that charge higher fees, and there are plenty of examples in the industry of leading managers charging exorbitant fees because investors know it is worth it. For instance, the holy grail of hedge funds, Renaissance Technologies' famed Medallion fund, charges its investors more than double the once-standard 2-and-20 — and would have allocators knocking down their door if they opened to new capital.

Bergstrom is also happy to support firms when it makes sense.

For example, he said, a small firm they're invested in asked for a fee increase because their talent was at risk of being poached by some of the pod shops.

"They told us that this was to pay their people, not themselves," he said.

"We thought that was very reasonable and went ahead with it."