Finance
In the world of hedge funds, a lucrative practice known as "passthrough fees" has become increasingly prevalent, allowing managers to charge investors for a wide array of expenses, from talent acquisition costs to mobile phone services. This fee structure, common among multistrategy hedge funds like Balyasny Asset Management, Citadel, and Point72 Asset Management, has led to a significant erosion of investor gains, with some firms retaining as much as 59 cents of every dollar they generate for clients1.
The Rise of Passthrough Fees
Passthrough fees have become a hallmark of multistrategy hedge funds, which operate by employing numerous trading "pods" to capitalize on diverse market opportunities. These fees allow firms to pass on various expenses to investors, including compensation, technology investments, and even employee perks like education and retirement contributions. The list of eligible expenses has expanded significantly over the past decade, with some firms now specifying items such as artificial intelligence costs and internal referral payments1.
In 2023, Balyasny's main hedge fund achieved a gross return of 15.2%, but investors received only 2.8% after paying over $768 million in fees, primarily for talent acquisition and compensation. This scenario illustrates how passthrough fees can drastically reduce investor returns, even in years when the fund performs well1.
Industry Perspective
While some investors view these fees as a necessary cost for accessing top-tier talent and technology, others criticize them as excessive. Joe Reilly, CEO of Circulus Group, described passthrough fees as "wild," noting that investors are essentially paying for everything, including copier paper1. However, proponents argue that these fees enable firms to deliver more reliable and diversified returns, which are crucial for maintaining investor confidence.
Citadel, for instance, reported that its three largest funds accumulated nearly $12.5 billion in passthrough fees from early 2022 to September 2024, with most of this amount going toward employee compensation and benefits. Despite these substantial fees, Citadel's gross return of 60% in 2022 still yielded a net gain of 38% for investors, outperforming the S&P 500 significantly1.
Regulatory and Transparency Concerns
The lack of transparency in how these fees are allocated has raised concerns among investors and regulators. While firms like ExodusPoint provide detailed lists of covered expenses, others, such as Citadel and Millennium, use broad catch-all phrases, leaving investors with limited insight into how their money is being spent1. This opacity has led some investors to question whether they are paying for unnecessary perks or lavish expenses.
Future Outlook
As the hedge fund industry continues to evolve, the use of passthrough fees is likely to remain a contentious issue. With more than 80% of multistrategy funds employing some form of passthrough structure, investors must carefully weigh the potential benefits of these funds against the costs1. While some firms have delivered impressive returns despite high fees, others may struggle to justify their expenses, particularly in years with lower performance.
In conclusion, while passthrough fees have become a standard practice in the multistrategy hedge fund sector, they pose significant challenges for investors seeking to maximize their returns. As the industry navigates these complexities, transparency and regulatory oversight will be crucial in ensuring that investors are fairly compensated for the risks they take.
Source:
Hema Parmar, Weihua Li, Kyle Kim, Armand Emamdjomeh, Bloomberg https://www.bloomberg.com/graphics/2025-hedge-fund-investment-fees
Image Credit: Rune Fisker