Almost half (44 per cent) of hedge funds are considering changing their fee structure from the traditional ‘2-and-20’ model, analysis from IG Prime has revealed.

The prime broker for hedge funds, other institutions and family offices found that hedge funds were increasingly looking to introduce more flexible fee structures, amid concerns that the industry had gone through “a long period of underperformance”.

The 2-and-20 fee structure refers to fund managers being paid 2 per cent of the fund’s assets under management and 20 per cent of the profits over an agreed benchmark.

Nearly three quarters (74 per cent) of hedge funds still use a traditional management fee structure.

Of those considering changing fee structures, 64 per cent believed it would give them a competitive advantage, while 16 per cent said pressure from clients was making them reconsider their fee structure.

“Many managers are feeling the pressure to be more flexible when it comes to their fees,” said IG Prime chief market analyst, Chris Beauchamp.

“There is a perception that the industry as a whole has delivered lacklustre returns over the last decade. That has led to asset allocators getting tougher in fee negotiations.”

“While the 2-and-20 structure has served hedge funds well, many funds and their clients no longer feel it’s appropriate.”

IG Prime also noted that rising cost pressures were squeezing hedge fund profits, with 43 per cent saying compliance was the largest cost pressure, followed by the need to invest more heavily in technology (42 per cent).

Almost three quarters (72 per cent) of managers expected artificial intelligence (AI) to have a significant or game-changing impact on them, especially its ability to automate laborious and costly processes.

Predictive insights and forecasting was the area that the largest proportion of hedge funds believed will be significantly impacted by AI, cited by 54 per cent of managers, while 50 per cent expected AI to significantly impact algorithmic trading.

“Rising cost pressures and demand for lower fees means managers are feeling the pressure to become more cost-efficient,” said Beauchamp.

“Hedge funds are finding that AI is emerging as one way to do that and it is expected to significantly impact a lot of the core functions of hedge funds, right through to the generation of benchmark beating returns.”

Despite the optimism around the potential of AI, only 25 per cent of funds felt AI would significantly impact the generation of alpha.

Furthermore, concerns were raised that AI could increase the risk of herd behaviour if too many investors use the same base AI model, and the risk of managers putting themselves in a position where they cannot explain the investment decisions made by their AI.

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