Download this Paper Open PDF in Browser

Determinants and Implications of Fee Changes in the Hedge Fund Industry

44 Pages Posted: 19 Mar 2012 Last revised: 11 Nov 2012

Vikas Agarwal

Georgia State University; University of Cologne - Centre for Financial Research (CFR)

Sugata Ray

University of Florida - Warrington College of Business Administration

Date Written: March 15, 2012

Abstract

Using a novel dataset that tracks daily changes in hedge fund fee structure, we examine the determinants and consequences of changes in the three components of the fee structure, namely the management fee, incentive fee, and the high-water mark provision. We find that funds respond symmetrically to past performance by increasing and decreasing their incentive fee following good and poor performance respectively. Further, funds increase their management fee after higher capital flows to mitigate decreasing returns to scale while larger funds decrease their management fee to pass on the economies of scale to the investors. Increase in the incentive fee is typically accompanied by addition of the high-water mark provision to mitigate the risk-taking behavior. Competitive forces in the hedge fund industry also drive the fee changes as funds which deviate from the average fees within their investment style tend to change their fees towards the average. Fee changes affect both future fund performance and investor flows. Future performance is worse subsequent to fee increases but there is no improvement in the future performance for fee decreases. Fund flows tend to be higher after fee decreases, a result driven by the management fee rather than the incentive fee. These findings indicate fees being determined by the bargaining between managers and investors while consequences of fee changes reflect the opportunistic behavior of managers in expropriating surplus from their investors.

Keywords: hedge fund fees, management fee, incentive fee, high watermark, performance, capital flows

JEL Classification: G11, G20

Suggested Citation

Agarwal, Vikas and Ray, Sugata, Determinants and Implications of Fee Changes in the Hedge Fund Industry (March 15, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2024362 or http://dx.doi.org/10.2139/ssrn.2024362

Vikas Agarwal (Contact Author)

Georgia State University ( email )

35 Broad Street,
Suite 1221
Atlanta, GA 30303-3083
United States
404-413-7326 (Phone)
404-413-7312 (Fax)

HOME PAGE: http://www.gsu.edu/~fncvaa

University of Cologne - Centre for Financial Research (CFR)

Albertus-Magnus Platz
Cologne, 50923
Germany

Sugata Ray

University of Florida - Warrington College of Business Administration ( email )

Gainesville, FL 32611
United States

Paper statistics

Downloads
230
Rank
111,293
Abstract Views
1,077