Tower Fund Services Explains: Management Fees

It has been an unofficial standard or expectation that hedge funds charge a 2% per annum management fee. Managers like to look at their management fees and performance fees as related fees that are dependent upon each other. There should not be any correlation between the two fees. The management fee should be what you need to keep your infrastructure up and running so you can do your job and work for your investors. The performance fee should be all but forgotten, as it is a bonus that you cannot rely on in any way.  We know, we know, your models and back-testing have been incredible and you will be making a fortune for your investors which will give you your big pay day every year in performance fees. A word to the wise: don’t count on it.

When thinking about your management fee, start with the 2% and ask yourself the question that investors will ask, “What do I get for this 2% fee?” Your answer should be derived from your business plan and operating budget. What is the cost of running your firm? Is there a need for specialized trading programs and analysts? You need to keep the lights on.

Some investment strategies that require boots-on-the-ground work, such as private equity, venture capital or real estate funds, have structured fee arrangements that incorporate a lower periodic management fee with an acquisition fee or a cost absorption component. With the cost absorption component, make sure you have a clearly defined scope of expenses that the fund may absorb. The regulatory agencies are paying close attention to these expenses to ensure the managers are charging back items that are appropriate.

As your fund grows, you can expect some larger investors to focus more on your management fee. That’s because they often see managers of large funds getting paid huge management fees that more than cover the cost of running the firm, and the managers have been dis-incentivized to produce returns because they are getting a big fat check every month. They’ve become asset gatherers versus asset managers. If this describes you, expect a demand for reduction in fees or at least a cap that covers your costs.

What about fee concessions for allocators, seeders, and founder shares? Do you take a large allocation ($25 million to $50 million) at zero fees and performance? Hell, yes! Get those assets under management!

 



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