Amidst greater fee scrutiny, advisors and clients need conversations about how to weigh outcomes of hedge fund strategies against costs and investment mandates.GETTY IMAGES
For years, hedge funds occupied a rarefied corner of the investment industry. High-net-worth clients were willing to pay premium fees in exchange for access, flexibility and the promise of outsized returns.
Now, advisors are facing three trends: hedge fund strategies are available increasingly as core allocations across the client spectrum; low-cost exchange-traded funds have reshaped investor expectations on how much they’re paying for those strategies; and regulators are pushing for greater fee transparency.
More than ever, advisors are being asked whether hedge funds are worth their fees.
The answer depends on what role the strategy plays within a portfolio, says Maili Wong, senior wealth advisor and senior portfolio manager with the Wong Group at Wellington-Altus Private Wealth Inc. in Vancouver. “Value depends on the mandate.”
She frames the value proposition of hedge funds through a broader portfolio-construction lens. Ms. Wong says the benefit can revolve around diversification, downside protection, alpha generation or volatility management.
“The value can come from being a non-correlated asset to the rest of your portfolio, so providing risk management and diversification. There’s also the return-enhancing idea, in which strategies with a high equity barrier, or something that’s going to generate higher returns for the amount of risk, can also generate a lot of value.”
The challenge for advisors is determining whether the fee structure aligns with the value being delivered.
Ms. Wong points out that hedge fund fee structures have evolved. Although the industry was once known for charging a 3 per cent management fee plus a 30 per cent performance fee on profits, many strategies now sit closer to a 1.3 per cent management fee paired with a 15 per cent to 20 per cent performance fee. Still, she cautions that the details behind those fees are important.
“Years ago, some hedge funds had a high performance fee and were taking larger risks and much more volatility.”
Structures such as high watermarks and hurdle rates can help align portfolio manager incentives with investor outcomes.
“I’m looking for them to use a perpetual high watermark and a minimum threshold of return before any level of performance bonus is achieved,” says Jay Nash, senior advisor and portfolio manager with Nash Family Wealth Management at National Bank Financial Wealth Management in London, Ont.
But headline fees themselves are only part of the equation. Ms. Wong says investors often overlook pass-through expenses such as trading costs, research expenses, data subscriptions and technology infrastructure.
“The all-in cost can be quite high because expenses are uncapped and can be charged regardless of performance,” she says.
That issue could become more visible as new total cost reporting (a.k.a., CRM3) rules expand fee transparency across the industry. Although CRM3 applies to mutual funds and ETFs, the indirect effect on vehicles such as hedge funds could be beneficial to clients.
“A heightened awareness of what those actual [mutual fund and ETF] fees are generally could bring wider fee compression,” Ms. Wong says.
Mr. Nash expects greater scrutiny as well, particularly if investors begin seeing a more complete picture of what they’re paying on their other investments.
For advisors, the bigger challenge may be helping clients evaluate hedge funds beyond headline numbers.
Ms. Wong points to 2022, when stocks and bonds both declined sharply, while some hedge fund strategies delivered positive returns through long-short positioning, commodities exposure or volatility trading.
Mr. Nash often approaches hedge funds more as tools for stability within portfolios and less as aggressive return generators.
“I tend to use them as a bond replacement,” he says. “I’m looking for consistency of return, limited downside and income-like returns.”
Both advisors stress that liquidity terms and portfolio manager behaviour deserve as much scrutiny as fees and performance. For Ms. Wong, manager selection is paramount, particularly in a space in which transparency can vary widely between strategies.
“Demonstrated track record – real results – are the most valuable indicators,” she says.
As hedge funds become increasingly accessible through liquid alternatives and prospectus structures, the conversation around fees is becoming more sophisticated and grounded in portfolio outcomes.
“We lead with what the fee buys, not what it costs,” Ms. Wong says.