Hedge funds too jump to trail commission regime

Seen to be healthier, for diverse reasons, than the traditional upfront percentage model, including getting investors for the long term

The ongoing debate on switching from an upfront to a trail commission regime in mutual funds seems to find some resonance in the hedge fund sector as well.

Local hedge funds, which started operations only over the past two to three years, are exploring the model. They are experimenting with paying distributors a percentage of the assets under management (AUM) every year, than paying an upfront commission.

“This is seen to be a healthier practice. Also many hedge funds are boutique players and are unable to shell out large amounts in upfront costs,” said Vaibhav Sanghavi, managing director, Ambit Investment Advisors.

Radhika Gupta, business head, Forefront Capital, an Edelweiss Group company, said conversations with new distributors show they are turning away from the upfront commission model. “They have expressed a preference for getting their income on a sustainable longer term annuity basis, rather than in the form of an upfront fee, a one-time affair. In some cases, there is also an element of participation in the carry fee. This is emerging as an alternative to the traditional upfront-plus-trail model,” she said.

The carry fee relates to a share of the profits a hedge fund gets if the investor makes money in the fund. Distributors are also being offered a piece of this profit, rather than a commission model overly dependent on an upfront payment.

Typically, upfront commission is what is paid immediately to a distributor when the product is sold to a customer and is usually a percentage of the investment made. For example, consider an asset management company which pays 1.5-2 per cent as upfront commission. It would pay Rs 1,500-2,000 to the distributor every time an investment worth Rs 1 lakh is made. In addition, the asset manager may pay an additional trail commission on a yearly basis, calculated as a percentage of the AUM. This could be lower, generally around 0.5 per cent.

The MF sector and the distributor community, as well as the Securities and Exchange Board of India, are reportedly considering an inverted structure, where most  earnings come from trail commission rather than upfront commission. The idea is to create an incentive for distributors to get investors for the long term, removing the incentive for getting them to switch products often.

The AUM of the hedge fund sector has doubled since the year the regulator officially recognised these as a separate investment category. Assets are up 107 per cent from $189.4 million in 2012 to $392.9 mn at the end of 2014, according to data from Eurekahedge.

The focus towards an increased trail commission comes even as investor interest has picked up, following a period of relative outperformance. India-based hedge funds outperformed foreign peers in 2014, up 50.8 per cent. Similar funds based abroad have given returns of 44.2 per cent.

“If this segment is to grow, people need to be more long-term. Distributors need to be willing to be less greedy and invest in growing the asset class. Managers need to  less greedy and share the fees. And, charges to clients have to be reasonable, so they make a decent return on the investments. If everyone is looking to making fees before they make returns for investors, this sector will never take off,” said Anuj Didwania, managing director, Redart Capital Advisors, which runs an Indian hedge fund.