Andrew Beer

This article was authored by Andrew Beer, founder of Beachhead Capital Management LLC in New York.

By one estimate, the hedge fund industry managed $2.6 trillion in capital at year-end 2013. Many expect growth to accelerate over the coming five years as institutional investors like US pension funds seek alternatives to investing in low yielding fixed income assets. Deutsche Bank, for example, predicts that industry assets will grow by another $400 billion this year alone.

This growth comes in the face of widespread discontent about the cost of investing in hedge funds. In the pre-crisis period, when hedge funds routinely outperformed traditional assets, the cost of investing was largely overlooked. In recent years, though, as the average hedge fund delivered single digit returns, high fees increasingly have come under scrutiny. To put the issue in context, investors paid approximately $95 billion in fees in 2013, or 44% of what their investors took home. By our estimate, this figure is twice what it should be: in other words, investors overpaid by a staggering $47 billion. The same conclusion can be drawn for each year since the financial crisis.

Why is this? In the post-crisis period, institutional investors and their consultants partially brought down the cost of investing by "dis-intermediating" funds of hedge funds - in essence, cutting out the middleman. However, this represented only a small percentage of overall fees. Driven in part by risk aversion (you don't get fired for hiring IBM), those same investors instead steered capital directly to the largest hedge funds - the $10 billion plus firms you read about in the press. By some estimates, 100% of net capital inflows post-crisis went to the top 100 man......................

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This article was published in Opalesque's New Managers a top-down monthly analysis, news and research publication on the global emerging manager space.