Understanding the Rising Investor Discontent Over Hedge Fund ‘Passthrough Fees’
Across the United States, a growing chorus of hedge fund investors is expressing frustration and, in some cases, walking away from funds due to what they call ‘passthrough fees’. These fees, often shrouded in complexity, require investors to shoulder nearly all operating expenses — including rent, travel, and even multimillion-dollar compensation for fund staff — on top of the traditional management and performance fees. This surge in dissatisfaction signals a critical moment in the hedge fund industry, blurring the once-clear lines between investment returns and fees.
What Are Passthrough Fees and Why Are They Controversial?
Unlike the familiar “2 and 20” fee structure — a 2% management fee and 20% performance fee — passthrough fees impose additional charges. They compel investors to reimburse nearly every operational cost fund managers incur. This practice is widespread in multistrategy hedge funds, colloquially known as “pod shops,” which have proliferated over the past decade.
Investors feel these fees are excessive, often leaving them with a fraction of the profits they expected. For example, a public pension official from New Mexico, Michael Shackelford, the chief investment officer for the Public Employees Retirement Association of New Mexico, has made it clear: “If you’re taking more than half of the profits, we won’t even talk to you.”
Five Key Players in the Passthrough Fee Debate
- Texas Teacher Retirement System: A massive $200 billion pension fund pushing for clear profit retention thresholds.
- New Mexico Public Employees Retirement Association: Enforces a hard rule to keep at least 60% of profits.
- Erlen Capital Management: A family office demanding at least 65-70% of gross returns and willing to pull funds when fees are prohibitive.
- Large Multistrategy Hedge Funds: Firms like Millennium Management, Citadel, Point72, Balyasny, and ExodusPoint, which commonly impose passthrough fees.
- Institutional Investors: Signing open letters and demanding fee waivers unless clear benchmarks are surpassed.
Investor Backlash and Changing Expectations
Over the past year, the pushback against passthrough fees has intensified—most notably led by Texas Teachers, which rallied over 60 other institutional investors in an open letter urging hedge funds to waive fees when returns fail to eclipse short-term Treasury bills. This movement reflects growing investor impatience amid a backdrop of faltering hedge fund returns.
Recent performance figures highlight this tension: Citadel and Millennium reported post-fee returns of just 2.5% and 2.2%, respectively, in the first half of 2025. Meanwhile, BNP Paribas data reveals that by 2023, investors were retaining only 41 cents on every dollar earned from multistrategy funds, down significantly from 54 cents just two years prior.
Why Fund Managers Resist Change
Fund managers defend passthrough fees as vital for sustaining the infrastructure supporting their complex trading strategies — including hundreds of trading teams, advanced technology, and top-tier pay packages. They argue that these costs reflect the operational reality of running cutting-edge, multifaceted investment platforms.
However, investors are questioning if this model still offers value, especially as net returns dwindle. The debate underscores a broader tension between fund managers’ need for resources and investors’ demand for transparency and fairness.
Institutional Stakes and the Road Ahead
Institutional investors hold significant sway over hedge funds’ future fee structures. For instance, New Mexico’s pension holds roughly $1 billion (5.64% of its total portfolio) in hedge funds, while Texas Teachers has $21 billion (over 10%). These sizeable commitments enable them to wield influence on fees and investment terms.
Looking ahead, these investors are tightening standards for new hedge fund commitments and adopting more rigorous fee scrutiny during due diligence. Bruno Schneller of Erlen Capital stresses that this is not about being “anti-fee,” but about responsible stewardship: “In this climate, fee discipline isn’t a luxury — it’s a fiduciary necessity.”
Expert Insight: What This Means for the American Investment Landscape
The friction surrounding passthrough fees highlights a critical inflection point in how hedge funds approach investor relations and fee transparency. From a regulatory and policy perspective, stronger disclosure requirements could restore some confidence and fairness to this sizable segment of the investment market.
Moreover, as public pensions and institutional investors grapple with balancing returns against transparency, their decisions will ripple through the broader financial ecosystem. Heightened investor scrutiny may compel funds to reconsider fee structures, innovate business models, or risk losing capital in an increasingly selective environment.
Questions Raising for Policy Makers and Investors
- Should there be standardized regulations governing passthrough fee disclosures?
- How might pension fund fiduciaries balance the pursuit of high returns with demands for fee visibility?
- What role can financial advisors and consultants play in negotiating fairer fee terms for clients?
Editor’s Note
As hedge fund investors grow more assertive in challenging opaque passthrough fee practices, the industry faces a pivotal test in balancing operational costs with investor returns. This evolving discourse underscores the fiduciary responsibilities of asset managers and the increasing demand for transparency. Investors and policymakers alike must engage thoughtfully to shape a more equitable and sustainable hedge fund landscape in the years ahead.
