Hedge Fund Investors Gain Power

For years pension funds, university endowments, and other big investors essentially wrote blank checks to hedge funds and private equity firms. They readily paid stiff fees and agreed to onerous restrictions. Investors had no choice if they wanted access to the money managers and outsize gains.

All that is changing. With returns dismal and cash scarce, investors are demanding—and winning—concessions on everything from cost to oversight. "The balance of power has shifted," says a private equity executive.

In recent months some of the biggest institutional investors, including the $175 billion California Public Employees' Retirement System, have gathered at closed-door meetings in New York and Toronto to talk about ways they might flex their newfound muscle. A number of public pensions, such as the $16 billion Utah Retirement System, have pushed firms publicly to ease terms. "This is top of mind for investors," says John-Austin Saviano at Cambridge Associates, a consultant to major investors.

Fees are issue No. 1. Private equity firms and hedge funds historically have levied annual management fees of 2% of assets, plus 20% of any gains. Many top firms charged more. Investors are no longer in the mood to pay so much. Larry Jordan Rowe, an attorney at Ropes & Gray who advises investors, says his clients are unhappy when they're "not making a penny on the portfolio and the firm is making a lot of money."

While firms that trump their peers will always be able to command premium prices, others will have to compete for investors' money. A partner at one private equity startup says she has had to be flexible to attract investors. The firm is charging 1.5% a year and taking 15% of profits. Even firms that are more established are feeling the pressure. TA Associates, a private equity firm with $12 billion, cut its take of gains on a new fund to 20% from 25%. TA did not respond to requests for comment.

TRANSPARENCY ISSUES

Firms are agreeing to other breaks as well. Some funds have performance targets: If their numbers fall short, firms would be subject to "clawbacks," arrangements under which they return some fees to investors. Others will have to cut expenses as assets swell.

Some investors want more disclosure from tight-lipped asset managers. Hedge funds and private equity firms typically issue financial statements quarterly, and some never reveal holdings. Larry Powell, deputy chief investment officer of the Utah Retirement System, noted in an open letter to hedge funds that "a lack of transparency has prevented investors from accurately gauging portfolio risk." He's calling for new standards, such as reporting returns weekly or daily. A few firms have agreed.

Private equity and hedge fund managers would prefer the status quo but fear losing big investors, who finally have other options. Instead of plowing money into new funds, for example, investors can buy into an existing portfolio cheaply on the secondary market: Some private equity funds are trading at a 50% discount. There's also the worry that the biggest pension funds will open their own hedge fund and private equity operations. That's making it difficult for money managers to get more assets without giving in to investors. Says one private equity manager: The fund-raising environment is "brutal, just brutal."

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