Hedge funds comply as Texas endowment seeks ‘fair and just’ fees

A move to restructure hedge fund fees is spreading in Texas.

The University of Texas Investment Management Co. is trying to change how its hedge fund managers are paid using a model known as 1-or-30, which charges a 1% management fee or 30% of performance — whichever is higher. The plan, begun in recent months, follows a similar effort started last year by the $142 billion Texas Teacher Retirement System, Austin.

Britt Harris, the former chief investment officer at Texas Teachers who took over as head of UTIMCO in August, is leading the effort he calls "project fair and just." The plan is to guarantee that institutional investors receive at least 70% of the gains from hedge funds even when returns lag behind the broader market, as they have for many funds for much of the past decade, Mr. Harris said.

Hedge funds typically charge 2% of assets in management fees and 20% of profit. That model has been under scrutiny as funds have struggled to match market benchmarks.

Funds overall gained 5.2% this year through November, trailing the 20% return for the S&P 500, according to data from Hedge Fund Research.

UTIMCO, which oversees $29 billion of endowments for the University of Texas and Texas A&M University, said six funds overseeing $2.5 billion of its assets will reset how they charge for management and performance. The new structure means they could get paid as little as 1% on assets if they don't meet a performance target. Six other funds have been approached and "we expect most of them to agree as well," Mr. Harris said in an email.

"They're listening to us," he said of the fund managers at a Nov. 29 meeting of UTIMCO's board of directors.

UTIMCO has at least $4.6 billion of hedge fund investments, including managers such as Baupost Group and Bridgewater Associates, according to reports from the non-profit. It declined to say which of the 30 funds it invests with are renegotiating fees. The funds contacted declined to comment.

Mr. Harris was Bridgewater's CEO for less than a year before joining Texas Teachers in 2006.

Texas Teachers has 43 fund investments with 38 managers, a spokeswoman said. About 70% of its hedge fund assets have a fee structure in line with Texas Teachers' philosophy, she said. Carlson Capital was the first fund to agree to renegotiated terms with Texas Teachers, the pension fund said. A spokesman for Dallas-based Carlson declined to comment.

Managers across the industry have cut fees including Brevan Howard, which has been experimenting with its structure to retain clients. Unhappy pension funds and endowments have slashed their allocations to hedge funds.

The problem with the traditional fee structure is that it overpays hedge funds when they underperform, according to Jonathan Koerner, a partner at Albourne Partners, which advises investors on alternative assets.

Mr. Koerner worked as a consultant with Texas Teachers last year on the 1-or-30 model. "Everyone wants lower fees but it's not just about concessions," he said in an interview.

About 60 hedge fund managers globally have embraced the structure, up from just 16 in mid-February, Mr. Koerner said. "I don't think we could have imagined the rate of adoption in the industry," he said.

Mr. Koerner said not all funds agreed with the changes — some top performers refused while others parted ways with Texas Teachers. UTIMCO is also an Albourne client.

Timothy Spangler, a partner at the law firm Dechert who specializes in private investments, said the Texas Teachers and UTIMCO fee structure may help align performance and profit.

"There's not been that much innovation around the fee structure," he said. "Hopefully it gains traction and is a first shot in a series of innovations."