Since the financial crisis of 2008, a big power transition has occurred in the alternatives industry.
Limited partners gained much more clout, which has allowed them to wrangle some concessions that would have been all but unthinkable before the crisis. Redemptions are easier, that's for certain. Towers Watson has been at the fore of the movement to reform asset management fees in the alternatives industry, and it has come out with new research that hits some of the key issues. Its recommendations are certainly eye-catching.
Regarding management fees, the 1-2 percent industry standard makes less sense than a system that would align management fees with operating costs. While novel, a few firms have taken steps toward this. The idea is that the management fee should be enough to keep the company afloat, while performance fees represent the main avenue for manager income.
Regarding performance fees, "generally used to pay staff bonuses and equity holders and typically charged at 20% of returns, we believe historical performance fee structures do not sufficiently align manager and investor interests. Managers share profits, but there is often no mechanism for them to share losses so there is an incentive to take excessive risk rather than targeting high long-term returns. Structures that contain hurdles, high watermarks and those that defer fees with the ability to claw back in the event of subsequent drawdowns are therefore preferable."
Towers Watson says that well-aligned structures will include: Management fees that properly reflect the position of the business, appropriate hurdle rates, non-resetting high watermarks, extension of the performance fee calculation period, clawback provisions, and reasonable pass through expenses. To be sure, many funds have embraced some of these recommendations already.