Hedge fund fees take a haircut

The sacrosanct "2 and 20" fee system at hedge funds may be coming to an end. Hedge fund investors are tired of paying big fees for poor performance.

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.

In this market, other investment options are available to the hedge fund investors that haven't been there before.

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."

While this news affects few individual investors directly, it affects many individuals indirectly whose pension funds might be investing in hedge funds. No longer will their pension funds be paying fees for bad performance and having one fifth of the gains kept by the hedge fund manager.