Key Takeaways
- • A group of 29 institutional allocators, led by the Teacher Retirement System of Texas, published an open letter calling on the hedge fund industry to adopt cash hurdles before charging incentive fees.
- • The letter argues that a market neutral hedge fund with $1 billion in assets would have returned about $52 million in 2023 simply by holding cash at 5.25%, earning roughly $10.5 million in fees under a standard 20% incentive fee for zero risk.
- • Signatories include pension funds, endowments, sovereign wealth funds and foundations such as CDPQ, Singapore's GIC, Korea Investment Management and the MacArthur Foundation, plus consultants Aksia, Albourne and Verus.
- • Hedge funds returned 4.9% in Q1 2024 per Aurum data, trailing equities at 7.3% but outperforming bonds at -2.1%.
- • Agecroft Partners expects allocators to continue reducing hedge fund exposure after public pension hedge fund allocations rose to 6.5% in 2022 from 3.3% in 2010.
Summary
A coalition of 29 institutional investors, led by the Teacher Retirement System of Texas, has issued an open letter to the hedge fund industry urging managers to adopt cash hurdles in incentive fee arrangements. The letter, titled "Regarding the Usage of Cash Hurdles in Incentive Fee Arrangements," argues that allocators should not pay performance fees for returns that could be earned by holding cash. Under a cash hurdle, a hedge fund would not earn incentive fees until its return exceeded the cash rate.
The letter illustrates the issue with a hypothetical: a market neutral hedge fund with $1 billion in assets would have returned 5.25%, or $52 million, in 2023 by holding cash. Applying a traditional 20% incentive fee, the fund would have collected $10.5 million for taking on no risk. The signatories described this as unsustainable, particularly as the risk-free rate may remain elevated; three-year Treasuries currently yield 5.4%. "Earning cash returns is not the reason institutional LPs invest in hedge funds," the letter states.
Signatories include pension funds, corporate defined benefit plans, endowments, sovereign wealth funds and foundations, among them CDPQ, GIC, Korea Investment Management, UTIMCO, the Texas Permanent School Fund and the Public Employees Retirement System of New Mexico. Investment consultants Aksia, Albourne and Verus also signed. PERA CIO Michael Shackelford said the association believes hedge funds that do not use hurdle rates should at minimum employ the cash rate as a minimum hurdle. The Teacher Retirement System of Texas spokesperson said LPs wishing to add their name should contact the pension fund directly.
Performance context cited in the coverage shows hedge funds returned 4.9% in the first quarter according to Aurum data, outperforming bonds (-2.1%) but trailing equities (7.3%). Agecroft Partners research indicates hedge fund popularity among institutions is waning and that allocators are likely to continue reducing exposure, after public pension allocations rose to 6.5% in 2022 from 3.3% in 2010.
The letter illustrates the issue with a hypothetical: a market neutral hedge fund with $1 billion in assets would have returned 5.25%, or $52 million, in 2023 by holding cash. Applying a traditional 20% incentive fee, the fund would have collected $10.5 million for taking on no risk. The signatories described this as unsustainable, particularly as the risk-free rate may remain elevated; three-year Treasuries currently yield 5.4%. "Earning cash returns is not the reason institutional LPs invest in hedge funds," the letter states.
Signatories include pension funds, corporate defined benefit plans, endowments, sovereign wealth funds and foundations, among them CDPQ, GIC, Korea Investment Management, UTIMCO, the Texas Permanent School Fund and the Public Employees Retirement System of New Mexico. Investment consultants Aksia, Albourne and Verus also signed. PERA CIO Michael Shackelford said the association believes hedge funds that do not use hurdle rates should at minimum employ the cash rate as a minimum hurdle. The Teacher Retirement System of Texas spokesperson said LPs wishing to add their name should contact the pension fund directly.
Performance context cited in the coverage shows hedge funds returned 4.9% in the first quarter according to Aurum data, outperforming bonds (-2.1%) but trailing equities (7.3%). Agecroft Partners research indicates hedge fund popularity among institutions is waning and that allocators are likely to continue reducing exposure, after public pension allocations rose to 6.5% in 2022 from 3.3% in 2010.
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