Hedge-Fund Startups Dwindle as Managers Battle Pressure on Fees

The hedge fund industry, once a thriving landscape for new startups, has seen a significant decline in recent years. The primary reason behind this trend is the mounting pressure on fees, driven by investor preferences and regulatory pressures. This article explores the factors contributing to the decrease in hedge-fund startups and the fee reduction strategies implemented by managers to address investor concerns.

Investor preferences and regulatory pressures have significantly impacted hedge fund fee structures, contributing to the decline in startups. According to Preqin, the average management fee decreased from 1.75% in 2010 to 1.50% in 2019, while the average performance fee dropped from 19.5% to 19.0% (Source: Number 3). This shift reflects investors' demand for lower fees and more transparent structures. Additionally, regulatory pressures, such as the Dodd-Frank Act, have increased compliance costs for hedge funds, further squeezing profit margins. As a result, new hedge fund startups face intense pressure to reduce fees and offer more competitive terms, making it challenging for them to generate sufficient returns to cover operational costs and attract investors.

Market conditions and competition from established funds also play a significant role in the decrease of new hedge-fund startups. Higher interest rates and volatility create an environment where established funds can capitalize on their experience and resources, making it challenging for startups to compete. Additionally, the shift towards a greater range of prices across and within asset classes, along with periods of heightened volatility, favors established funds with diversified portfolios and proven track records. Furthermore, the pressure on fees, driven by investor demands for lower costs and higher returns, puts additional strain on new hedge-fund startups, which often struggle to match the economies of scale and operational efficiency of their more established counterparts.

To address investor concerns, hedge fund managers have implemented several fee reduction strategies. One such strategy is the use of claw-back provisions, which allow investors to claw back fees if subsequent losses occur. Another strategy is the implementation of hurdle rates, which set a minimum rate of return that the manager should generate before charging a performance fee. High-water marks are also used to ensure that performance fees are only paid on new profits generated by the manager. These strategies aim to align manager and investor interests, fostering a more sustainable hedge fund ecosystem.

In conclusion, the decline in hedge-fund startups can be attributed to a combination of investor preferences, regulatory pressures, market conditions, and competition from established funds. To address these challenges, hedge fund managers have implemented fee reduction strategies to better align their interests with those of their investors. As the industry continues to evolve, it is essential for managers to remain adaptable and responsive to the changing demands of investors and the market.