Hedge funds face investor war on fees

By Laurence Fletcher

LONDON (Reuters) - Institutional investors are going to gang up on "arrogant" hedge funds, a pension fund chairman warned, as investors increasingly press for changes that would link lucrative fees more closely to genuine outperformance.

A key complaint of investors has been that while many of them lost money during the financial crisis, hedge fund managers were still able to rake in millions of dollars in fees. Last year, average hedge fund returns were a minus 19 percent.

"If they want money from us they will have to offer ... alignment of interests. If hedge funds remain arrogant and not humble, I think money will go elsewhere," Philip Read, chairman of the British Coal Staff Superannuation Scheme, said on Tuesday.

"We're increasingly going to gang up against you... Institutional investors are totally disillusioned with funds not delivering what was on the tin," he told the the Hedge 2009 conference in London.

Hedge funds typically charge a management fee of 2 percent or sometimes more on assets -- well above the cost of mutual funds -- plus a 20 percent fee on performance, which is often levied on any positive returns not just those that fall above a "hurdle rate", or target agreed with the investor.

Institutional investors at the conference said they favoured skewing fees further towards performance and away from rewarding firms for the amount of assets gathered.

They also said managers should be rewarded when they deliver returns due to their skill -- known as alpha -- and not due to rising markets -- or beta -- as very cheap exchange-traded funds also offer investors beta.

"We're essentially trying to minimise non-performance-related fees. We want managers to make money when we make money," said Mike Powell, head of alternative investments at Universities Superannuation Scheme, Britain's second largest pension scheme.