Key Takeaways
- • Texas Teachers Retirement System (TRS), managing $133 billion in assets, negotiated an innovative "1-or-30" fee model with hedge fund managers as an alternative to the traditional 2-and-20 structure, addressing sustained underperformance in low-return environments.
- • TRS established a strategic goal that 70 percent of alpha generated should flow to the pension fund and 30 percent to managers, regardless of market conditions, after observing that fee structures in recent years had shifted 50–75 percent of alpha to managers—an unsustainable split in the pension's view.
- • Brad Gilbert, director of hedge funds at TRS, identified the core problem in early 2016: as gross hedge fund returns declined, net returns to large institutional investors deteriorated further due to fee drag, breaking the traditional performance-fee economics.
- • The new fee structure gained acceptance among the majority of TRS's hedge fund managers once they understood the model, though some managers who rejected the terms risked losing allocation from the $133 billion plan.
- • TRS's approach represents a broader institutional pushback against traditional hedge fund fee structures, positioning the pension plan as a market leader in renegotiating manager compensation to align incentives with investor returns in lower-return market regimes.
Summary
The Teacher Retirement System of Texas, one of the nation's largest public pension plans with $133 billion under management, moved to fundamentally reshape its relationship with hedge fund managers by introducing an alternative fee structure designed to protect net returns in a persistently low-return environment. In early 2016, TRS leadership identified a critical problem: as hedge fund gross returns declined, traditional 2-and-20 fee arrangements (2 percent management fee plus 20 percent performance fee) were consuming an disproportionate share of investor returns, leaving insufficient net gains for pensioners.
Brad Gilbert, TRS's director of hedge funds, articulated the philosophical foundation for change: "Our basic philosophy is that the approximate split of alpha between investors and managers should be 70 percent to 30 percent." Under this principle, 70 percent of alpha generated should accrue to the pension fund while managers retain 30 percent. However, in the preceding years, the actual distribution had inverted dramatically, with managers capturing 50–75 percent of alpha while TRS received the remainder—a split Gilbert characterized as "not sustainable to the industry." This deterioration occurred precisely when alpha generation was most difficult, creating a misalignment between manager compensation and investor economics.
TRS's response was the development of a "1-or-30" fee model, a structure that diverged sharply from the industry standard. Rather than accept continued fee drag, the pension negotiated terms with existing managers, with one fund agreeing to the new arrangement in an initial pilot. Jonathan Koerner, head of implementation at hedge fund consultant Albourne Partners and formerly with Utah Retirement Systems, confirmed the negotiation succeeded, though he declined to identify the specific manager involved. The TRS investment committee, believing further optimization was possible, pursued additional refinements to the model.
The reception among TRS's hedge fund manager base was notably positive once the structure was explained. A majority of existing managers accepted the 1-or-30 terms, recognizing both the philosophical coherence of the arrangement and the substantial asset base at stake—TRS's hedge fund allocation was material to most participating funds. Managers who declined the new fee model faced the prospect of losing access to TRS capital, a significant competitive consequence for any hedge fund dependent on large institutional allocations.
TRS's initiative reflects a broader institutional response to hedge fund fee structures. Other large public pension plans, including the California Public Employees' Retirement System (CalPERS) and the New York City Employee Retirement System, had responded to similar fee pressures by exiting hedge funds entirely. TRS chose instead to fix the transaction itself, positioning the pension plan as a market leader in fee renegotiation and signaling to the broader hedge fund industry that large institutional investors would no longer passively accept fee arrangements that erode net returns during periods of constrained alpha generation.
Brad Gilbert, TRS's director of hedge funds, articulated the philosophical foundation for change: "Our basic philosophy is that the approximate split of alpha between investors and managers should be 70 percent to 30 percent." Under this principle, 70 percent of alpha generated should accrue to the pension fund while managers retain 30 percent. However, in the preceding years, the actual distribution had inverted dramatically, with managers capturing 50–75 percent of alpha while TRS received the remainder—a split Gilbert characterized as "not sustainable to the industry." This deterioration occurred precisely when alpha generation was most difficult, creating a misalignment between manager compensation and investor economics.
TRS's response was the development of a "1-or-30" fee model, a structure that diverged sharply from the industry standard. Rather than accept continued fee drag, the pension negotiated terms with existing managers, with one fund agreeing to the new arrangement in an initial pilot. Jonathan Koerner, head of implementation at hedge fund consultant Albourne Partners and formerly with Utah Retirement Systems, confirmed the negotiation succeeded, though he declined to identify the specific manager involved. The TRS investment committee, believing further optimization was possible, pursued additional refinements to the model.
The reception among TRS's hedge fund manager base was notably positive once the structure was explained. A majority of existing managers accepted the 1-or-30 terms, recognizing both the philosophical coherence of the arrangement and the substantial asset base at stake—TRS's hedge fund allocation was material to most participating funds. Managers who declined the new fee model faced the prospect of losing access to TRS capital, a significant competitive consequence for any hedge fund dependent on large institutional allocations.
TRS's initiative reflects a broader institutional response to hedge fund fee structures. Other large public pension plans, including the California Public Employees' Retirement System (CalPERS) and the New York City Employee Retirement System, had responded to similar fee pressures by exiting hedge funds entirely. TRS chose instead to fix the transaction itself, positioning the pension plan as a market leader in fee renegotiation and signaling to the broader hedge fund industry that large institutional investors would no longer passively accept fee arrangements that erode net returns during periods of constrained alpha generation.
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