Why 2-and-20 is Here to Stay

So here's the weird thing about that Citigroup survey of pension-fund managers. Apparently the notorious 2-and-20 fee structure is doomed, even though the fund managers are going to increase their allocation to alternative investments:

Almost 60% of managers surveyed indicated that the 2/20 fee structure was unsustainable for private equity firms and almost 80% indicated that the fee structure was unsustainable for hedge funds. Having said that, almost 70% of US managers indicated that they are willing to pay the typical fee structure if the alternative manager’s performance warrants...
About 85% of pension managers will increase their allocation to alternatives over the next 3 years. Additionally, the alternative asset allocation within pension funds will approach 20% (vs. 14% currently) over that same time period.

The actual expected increase in alternative investments is 35%: from 14.4% of funds under management to 19.4%. So why on earth do 91% of European pension fund managers think that the 2-and-20 structure for hedge funds won't last another five years? It's lasted much more than that even as the number of hedge funds has exploded. Now that the inevitable consolidation is beginning in the hedge-fund industry, I see absolutely no reason to believe that anybody is going to move away from 2-and-20 any time soon.

But what about Mohamed El-Erian's move to Pimco, where he's going to beef up the west coast giant's presently nonexistent alternative-investments arm? Surely he won't be charging 2-and-20?

No, he won't, but (a) he will be investing in other hedge funds which do charge 2-and-20 (at least to non-Pimco clients); and (b) he's Pimco, and Pimco tends to be an exception to many rules.

For the time being, the most successful hedge funds continue to be those which charge more than 2-and-20, not less. So long as fees are perceived to be a sign of ability, no one's going to start discounting.