Hedge fund investors press for hurdle rates

Hedge fund investors press for hurdle rates

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European institutions want alternative fund managers to commit to hurdle rates - in some cases set at unrealistic levels given average investment returns - according to research house Cerulli.

Hurdle rates, commonly the rate of return that the fund manager must beat before collecting incentive fees, are being sought by 92% of the institutions surveyed by the firm.

"Even more troubling for alternative managers is the fact most institutions (60.5%) want the obstacle to harvesting incentive fees to be an absolute number. Only 31.6% of our respondents accept a 'Libor-plus' metric," notes David Walker, Cerulli's European institutional research director.

Almost half (47.6%) of the institutions surveyed by Cerulli deem hurdles of 7% to 8% to be appropriate, which Walker says will be challenging for some managers.

"Putting it in context, the US$ 2.9trn (€2.6trn) hedge fund industry fell short of this in four of the past five years," says Walker.

Nearly 29% of investors would like the obstacle to be set at 10% to 12%.

"Given the returns that Europe's institutional investors tell Cerulli they expect from four alternative asset classes, a hurdle of 10% to 12% may be better suited to private equity. Cerulli believes that managers should manage institutions' expectations about prospective returns, which should inform the thinking about appropriate hurdle rates," says Walker.

"The interests of managers and their clients should certainly be aligned, but the expectations on each side should be realistic."

Walker believes that an absolute hurdle rate of 4% to 6%--being sought by 19% of institutions Cerulli surveyed--might be more realistic for some other alternative classes, in the current climate.

Commenting on the research conducted for Cerulli's recently published inaugural European Alternative Products and Strategies 2016 report, Justina Deveikyte, a senior analyst at Cerulli, notes that poor returns have left Europe's institutions in a very strong position when it comes to negotiating investment terms.

"Even mid-sized institutions, that were previously destined to 'take what managers offered them', have won a newfound clout. Compounding the situation is the growing influence of consultants and the emergence of club deals between institutions hunting for yield," says Deveikyte.

Cerulli believes that alternative managers willing and big enough to recalibrate fees for their strategies will have a significant edge in competing for institutional clients.


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