'2 & 20' HF Compensation Model On Decline

Dec 9 2013 | 10:03am ET

The traditional '2 and 20' hedge fund compensation model may be going the way of the dodo, according to new research from Citi Prime Finance.

The Citi Prime Finance 2013 Business Expense Benchmark Survey says the tried and true 2%  management fee/20% of the profits model has declined, for all but the largest managers, due  in part to pressure to offer founders’ share classes or accept seed capital to launch with sufficient AUM. The Citi survey shows average fees for managers with less than $1 billion AUM range from 1.58%-1.63%.

As a result, according to Citi Prime, smaller managers “barely break even simply collecting fees.” Survey data show that after paying expenses, funds with $500 million in AUM realize operating margins of 69 basis points, rising to 82 basis points for a manager overseeing $900 million.

Citi Prime estimates hedge funds need “at least $300 million in assets” just to break even. 'Institutional' size hedge funds, on the other hand, with assets between $1 billion to $10 billion, begin to realize higher operating margins as they surpass $1.5 billion and can see appreciable profits as they approach and move beyond the $5.0 billion threshold.

“Fee compression continues to reshape the business of hedge funds, lowering fees even as expenses rise, all but eliminating fee-only operating margins, and raising the level of assets needed for a hedge fund business to succeed,” said Alan Pace, global head of prime brokerage and client experience. “And while it’s clear that there is little room for additional downward pressure on management fees, at current average fee levels, investor-manager interests are well aligned—both parties are focused on performance.”

The survey polled 124 hedge fund firms in North America, Europe and Asia representing $465 billion, more than 18% of total industry assets.


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