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Regulation Amp Governance
Private jets expensed with hedge fund fees
From the Financial Times of Sun, 05 Oct 2014 06:08:08 GMT
A new Netjets Inc. Global 6000 jet sits on the tarmac at the Teterboro Airport in Teterboro, New Jersey, U.S., on Friday, March 1, 2013. NetJets, the aviation business of Berkshire Hathaway, is a fractional-jet company whose clients take a stake in planes in exchange for flight hours. Photographer: Victor J. Blue/Bloomberg©Bloomberg

Some hedge fund managers are taking salaries, private-jet expenses and entertainment costs directly out of the funds they manage, according to investors and consultants.

Hedge funds notoriously charge high upfront fees, with the “2 and 20” model of a 2 per cent annual management fee and 20 per cent performance fee the historic norm.

Despite this, some are charging their costs and expenses to the funds they manage, eroding investors’ returns still further.

“We have seen some very bad examples, such as hedge funds paying salaries from the funds and private jets put through the fund expenses,” said Ed Francis, head of investment for Europe, the Middle East and Africa at Towers Watson, a consultant. He described these charges as “pernicious”.

“This is certainly very true of some of the larger established funds. They would put salaries and expenses through and that was pretty normal,” said a former fund of hedge funds manager, who declined to be named. The manager estimated the cost of such charges as around 30 basis points a year.

Phillip Chapple, executive director of KB Associates, an operational consultancy, said other hedge funds were charging marketing expenses, data fees and the costs of Bloomberg terminals and research directly to funds.

“I think a lot of managers see this as a way of eating up expenses that they incur as a fund manager,” he said. “It is very hard to look people in the eye and justify some of that stuff. If you find them doing this, then you wonder what else they are doing.”

The charges are legal if they are outlined in a fund’s offering memorandum or private placement memorandum. However, these documents are “typically written in a way to encompass most things imaginable”, according to Joshua Barlow, associate director at Paamco, a fund of hedge fund manager.

Many charges, such as those for audit fees, legal fees, administration costs and tax filings, are widely seen as legitimate.

Mr Barlow said he had seen “surprising” levies for “employee salaries, technology, regulatory filings, fund portfolio and accounting systems, outsourced middle office, insurance, trade errors, travel and entertainment” that, in some cases, are “so large that they raise the question ‘what is the management fee I am paying going towards?’”

“We have seen instances where they can be quite large,” said Stephen Oxley, managing director of Paamco. “They might say they need to use an executive jet to visit a company, but that doesn’t cut any ice for us. We have it in our sub-advisory agreements that we are not going to pay. We are not going to invest unless this is sorted out.”

Mr Francis said the most egregious abuses were being weeded out amid a greater focus on operational due diligence, as institutional investors increasingly replace wealthy individuals as the primary hedge fund investors.

Some allocators to hedge funds said they were willing to invest in the worst offenders if their performance was sufficiently good, while others admitted they did not have the resources to check exactly what they were being charged for.

“The onus is on the investor to understand what they are invested in [but] it is slightly hidden in the documentation. We had to go digging for it,” said the former fund manager.

Jack Inglis, chief executive of the Alternative Investment Management Association, said: “Managers disclose all fees and expenses that are directly or indirectly borne by investors.”

“We expect that the professional nature of hedge fund investors allows them to fully assess the appropriateness and the level of such fees prior to and during the life of their investments.”

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