As 2-and-20 fees under fire, Asia hedge funds seek cost cuts

July 5: When Ruhong Huang’s Hong Kong-based hedge fund crossed a key milestone after gathering $100 million in assets, he made an unusual choice. Rather than continuing to go it alone, he decided to join a “platform” to help his firm with everything from hiring administrative staff to handling compliance.

While Huang’s move is uncommon, he isn’t alone. Hedge fund platforms in Asia, which traditionally have helped fledgling firms with a few million dollars set up shop, are now seeing bigger managers turn to them to help save as much as 90% of their annual operating costs. That’s signaling a fundamental change in the economics of the hedge fund business, as investors are balking at the hefty “2-and-20” fees that were once a fixture in the industry and compliance costs are spiraling higher.

“The market has shown to be unforgiving of funds that lack strong operations,” said Huang, whose Credence Global Fund tapped the services of a firm called SwissAsia Financial Services Pte. “The costs and efforts of building out the institutional infrastructure to support a bigger fund add up very quickly and takes a lot of time.”

This shift is happening against an increasingly challenging environment for hedge funds, which had been struggling even before Britain’s vote to leave the European Union sent markets tumbling. Rising regulatory costs and volatile markets have led to more fund liquidations than launches for the first time in at least a decade, according to Eurekahedge Pte, and investors are pulling the most money from hedge funds since the global financial crisis. The $2.9 trillion industry is headed for its worst first-half performance since 2011, stymied by global shocks from China to London.

"I do think a greater proportion of startups will join a platform as the regulatory and compliance costs have risen, and look like they will keep rising in the future," said Howel Thomas, who runs a $37 million Hong Kong hedge fund, Wykeham Capital, which is supported on a platform run by Geomatrix HK.

Asia’s hedge funds lost 2.4% this year through the end of June, according to Singapore-based Eurekahedge, the worst start to a year since 2010. Investors, who’ve traditionally paid 2% in management fees and 20% of investment gains, are pushing back. The average hedge fund management fee stood at 1.63 percent last year and the profit share has declined to 17.9%, according to an annual survey published by Deutsche Bank AG in February.

Helping start-ups

As recently as three years ago, Swiss Asia catered to managers with assets ranging from $2 million to $40 million, according to Chief Operating Officer Steve Knabl. Today, the firm has two hedge funds on its platform that are larger than $75 million. Other firms that provide services, including OP Investment Management and Rogers Investment Advisors, also say they’re being approached by bigger hedge funds.

Such providers offer hedge funds a range of services, from giving them office space to assisting them with operational infrastructure, and even helping them hire lawyers and prime brokers. Many also have the capability to help hedge funds start operations across different markets. Some firms base fees on a percentage of assets, while others negotiate rates based on the level of support required. Hedge funds with more complex strategies and high-volume trading typically have to pay higher rates.

Cost savings

Hedge funds seeking to set up shop in Asia typically spend between $400,000 and $2 millionayear,accordingtoindustry estimates. A potential $2 million in annual costs can be reduced to $150,000, said Ed Rogers, chief investment officer of Rogers Investment Advisors,whichrunsoperations in Hong Kong and Tokyo.

“What sane businessman doesn’t want to save $1.85 million in costs as a startup?” said Rogers, who was previously the head of prime services and sales in Tokyo at Deutsche Bank AG before starting his own firm in 2006.

At the end of 2013, Black Crane, a hedge fund with offices in Hong Kong and Singapore, joined Wolver Hill Asset Management Asia, another firm overseen by Rogers, with $15 million in assets. The manager now has $40 million, according to Rogers.

While such firms aren’t unique to Asia, there is more demand because the region has different jurisdictions and many markets are not easily accessible for a single asset manager. The industry is also comparatively smaller, with assets at $172 billion, compared with $1.5 trillion in the US, and average fund sizes are about half of those in the US.

Asia has about ten serviceprovider focused firms such as Rogers and Swiss-Asia, founded in 2004 by Olivier Mivelaz, a former executive at Swiss bank Banque Cantonale Vaudoise. They are different from hedge fund “seeders,” or strategic investors, who often provide start-ups with seed capital in exchange for a stake in the funds or the fund management firm. They’re also different from prime brokers, who provide services like lending securities for shorting, executing trades or lending money. About $2.8 billion, or 2% of Asia-based hedge funds, are managed on a serviceprovider focused platform, according to Eurekahedge.

Bloomberg