In its research report “Hedge Fund Investing—Opportunities and Challenges,” the consultancy says a more equitable split of the skilled outperformance is a good basis for better-aligned fee structures, which for years have worked in favor of hedge fund managers, in many instances giving them the majority share.

The events of 2008 and the subsequent pressures faced by many hedge funds led to a re-evaluation of the value they added and how this was shared with investors, according to Towers Watson. The company says investors providing sizable allocations, with a long-term investment horizon, now find themselves in a position of considerable negotiating power, with the traditional 2+20 fee model coming under increasing pressure.

In addition to the usual annual management fee and a performance or “incentive” fee, Towers Watson says well-aligned structures will include:

•  Management fees that properly reflect the position of the business;

•  Appropriate hurdle rates;

•  Non-resetting high watermarks (known as a “loss carry-forward provision”);

•  Extension of the performance fee calculation period;

•  Clawback provisions; and

•  Reasonable pass-through expenses. 

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While it has some sympathy with hedge funds’ desire to retain any perceived informational and analytical advantage through reduced transparency, Towers Watson says it believes the dynamic of the industry has changed and managers must increasingly respect the fiduciary reporting requirements of institutional investors and their advisers.

The research report covers other aspects of hedge funds and investment opportunities including:

• Industry trends in managed accounts and UCITS hedge funds;
• Investment strategies: Event-driven funds; managed futures/systematic strategies; and active currency; and
• Alternative beta: opportunities in reinsurance, emerging market currency and volatility.

The report is available at http://www.towerswatson.com/research/6925.