Hedge Fund Fee Dissatisfaction and Investor Activism: Navigating Structural Shifts and Fee Arbitrage in Private Capital Markets

The private capital markets are undergoing a seismic shift as institutional investors increasingly reject traditional fee models and embrace activism to reshape the industry. At the heart of this transformation lies a growing dissatisfaction with the long-standing "2 and 20" structure—2% management fees and 20% performance fees—and a parallel surge in investor activism targeting governance, performance, and capital allocation. These trends are not isolated but interconnected, creating fertile ground for fee arbitrage strategies that prioritize alignment of interests and risk-adjusted returns.

The Fee Model Revolution: From "2 and 20" to Hurdle Rates

For decades, the "2 and 20" model dominated hedge funds, but its flaws have become glaringly apparent. Research by LCH Investments reveals that since the 1970s, investors have paid nearly 50% of gross gains in fees, with $1.8 trillion siphoned from $3.7 trillion in pre-fee returns. This has fueled a demand for hurdle rates—thresholds that require funds to outperform a benchmark (often cash) before charging performance fees.

A 2025 BNP Paribas survey found that 66% of investors now prefer hurdle rates, up from 15% in 2022. This shift is driven by macroeconomic factors: rising interest rates have made cash returns more attractive, pushing investors to demand "cash plus" performance. Goldman Sachs data further underscores the gap between investor expectations and industry practices: 44% of managers are considering fee changes, yet only 30% currently offer hurdle rates.

The decline in fees is already evident. By 2023, average management fees had fallen to 1.35%, and performance fees to 16.01%—levels not seen since the 2008 financial crisis. ExodusPoint Capital Management's adoption of a "cash hurdle" in September 2024 exemplifies this trend, aligning manager compensation with investor returns. Such moves are not merely defensive; they are strategic, as funds that fail to adapt risk losing assets to competitors offering performance-linked incentives.

Investor Activism: From Governance to Fee Arbitrage

Parallel to fee dissatisfaction, investor activism has evolved into a powerful tool for reshaping private capital markets. In 2025, 129 shareholder campaigns were launched in the first half alone, with activists increasingly targeting CEOs, pushing for M&A, or advocating for company break-ups. The rise of "swarm" campaigns—where multiple activists target the same firm—has forced companies to navigate complex, competing demands.

Activists are also leveraging fee arbitrage strategies. By pressuring funds to adopt hurdle rates or cash hurdles, they create a competitive edge for investors who demand performance-based compensation. For example, pension funds and endowments have successfully negotiated fee structures that tie manager compensation to outperformance over cash, effectively reducing costs during periods of low returns. This is a form of fee arbitrage: investors extract value by aligning fees with benchmarks they can control or predict.

Regulatory shifts further amplify this trend. The SEC's February 2025 guidance on Schedule 13G eligibility has reduced transparency in activist campaigns, but it has also incentivized more aggressive fee negotiations. Activists now operate in a landscape where institutional investors are less willing to tolerate opaque fee structures, creating opportunities for those who can demonstrate performance-driven value.

Structural Shifts and Investment Opportunities

The convergence of fee dissatisfaction and investor activism is reshaping private capital markets in three key ways:

1. Fee Arbitrage in Fund Selection: Investors are increasingly favoring funds with hurdle rates or cash hurdles, which reduce downside risk. For example, multi-strategy funds that maintain high fees are now outliers, as investors shift capital to funds with performance-linked structures. This creates a "fee arbitrage" opportunity: investors who commit early to funds adopting hurdle rates can secure better terms before the market normalizes.

2. Activism as a Fee-Reduction Tool: Shareholder campaigns are no longer limited to governance changes. Activists are now using proxy contests to push for fee reforms, such as eliminating performance fees during underperformance or renegotiating management fees. The success of campaigns like Mantle Ridge's at Air Products—where three activist-nominated directors were elected—demonstrates how governance shifts can directly impact fee structures.

3. Private Capital's Response to Fee Pressure: Private equity and venture capital funds are also feeling the heat. With private equity fundraising declining and investors demanding more liquidity, funds are adopting fee structures that mirror hedge fund innovations. For instance, separately managed accounts (SMAs) are gaining traction, allowing investors to pay higher incentive fees in exchange for better liquidity and transparency.

Strategic Recommendations for Investors

1. Prioritize Performance-Linked Fees: Allocate capital to funds that have adopted hurdle rates or cash hurdles. These structures reduce the risk of paying fees during periods of underperformance and align manager incentives with investor returns.

2. Engage in Fee Arbitrage: Use activism or proxy voting to push for fee reforms in underperforming funds. For example, demand that performance fees be tied to cash returns or that management fees be reduced during periods of low liquidity.

3. Monitor Regulatory Developments: The SEC's Schedule 13G guidance and universal proxy rules will continue to shape activist strategies. Investors should stay informed about these changes to anticipate shifts in fee negotiations and governance dynamics.

4. Leverage Data for Due Diligence: Use tools like Broadridge's fee analytics to compare fund performance against benchmarks. Funds that consistently outperform cash or hurdle rates should be prioritized, while those with opaque fee structures should be scrutinized.

Conclusion

The private capital markets are at an inflection point. Hedge fund fee dissatisfaction and investor activism are not just reshaping fee models—they are redefining the relationship between investors and managers. As hurdle rates become the norm and fee arbitrage strategies gain traction, investors who act decisively will find themselves in a stronger position to capture alpha while mitigating downside risk. The future belongs to those who recognize that alignment of interests is not a buzzword but a competitive advantage.