There are more single-family offices than ever before and on average they’re controlling larger pools of assets. Hedge funds are a core investment option for many of them. However, while some hedge funds are performing as “promised,” many others are not. This has caused consternation among family office investment officers, who are responding by taking a variety of actions.
While they certainly haven’t abandoned hedge funds, they’re changing how they select and monitor these funds, according to a survey of 71 single-family office executives who have allocated about $800 million to hedge funds. Close to half the family offices surveyed are domiciled outside the U.S.
Lower Fees
One of the most telling findings from the research is that the single-family offices are often negotiating down hedge fund fees, including those of hedge funds of funds. The survey looked at two groups of funds with which single-family offices are negotiating: hedge funds they’ve been involved with for two years or longer, and those they’ve used for less than two years.
The former are hedge funds with which the single-family offices have solid experience. Because of generally lackluster performance over the past two years, single-family offices have negotiated an average 0.7% decrease in management fees among this group. More importantly, they’ve pushed the incentive fees down by an average of 3.2% (Figure 1).
The average decrease in fees was not as substantial for hedge funds that family offices started investing in less than two years ago. The average decrease was 0.4% for management fees and 1.9% for incentive fees.
It’s important to note that these are averages; some hedge funds continue to collect full fees from single-family offices. Survivorship bias also needs to be considered. For example, the survey doesn’t include information on the hedge funds that wouldn’t lower their fees. Still, these findings and related research indicate that single-family offices have been increasingly assertive in their dealings with hedge funds, and it’s not just when it comes to fees.
Additional Concessions
Aside from getting hedge funds to lower fees, single-family offices are also exacting other types of concessions (Figure 2). About three-fifths of the single-family offices have exacted changes in hurdle rates. Of the 44 single-family offices that obtained a change in the hurdle rate, the average increase was 1.4%.
About a third of the single-family offices were doing “special deals” with some of the hedge funds they invested with. In one case, a hedge fund provides short-term bridge capital to businesses. It also selectively obtains equity in companies through side-pocket arrangements. As part of the deal to invest monies with the hedge fund, the single-family office can co-invest in these private companies alongside the hedge fund. In addition, the hedge fund doesn’t receive any fees when the single-family office is co-investing.
Almost a sixth of the single-family offices arranged for claw-back provisions if certain performance levels weren’t achieved. While conceptually attractive, clawbacks are often very hard to implement effectively.
It’s important to recognize that not all single-family offices that invest in hedge funds are negotiating fee arrangements. Also, even if a single-family office is negotiating hedge fund fees, that doesn’t mean it is doing so with all the hedge funds for which it is providing capital.
It’s all a matter of negotiating leverage. With performance issues and intense competition for capital, many single-family offices have clout with respect to hedge funds and are motivated to use it.
What we have is a very fluid environment. The current arrangements single-family offices have with hedge funds can easily and radically change. For example, if the general partners at a hedge fund can communicate a powerful investment philosophy and strategy buttressed by a formidable track record, then the hedge fund has the leverage to insist that single-family offices pay full price and maybe even a premium.
It’s likely single-family offices will become more and more assertive when it comes to the professionals and other providers with which they are engaged. To be clear, single-family offices are bargaining over fees, services and products not just with hedge funds, but with all their providers. Traditional industry norms are disintegrating and being replaced by guidelines that foster negotiated, customized pricing models.
