Hedge fund manager expense practices are firmly in the spotlight driven by rising operating costs, technology needs, complex regulatory obligations, fee compression, and heightened investor focus. The traditional “2 and 20” fee model has mostly been replaced by discounted or tiered management fees, higher hurdle rates, and segregated managed accounts with bespoke (generally lower) fees. Against this backdrop, managers seeking to preserve margins and protect revenue are reassessing the allocation of costs between the fund and the management company.

Competition for talent from large multi-manager platforms has put further strain on managers’ net revenues. As managers with traditional fee structures compete with multi-manager platforms that typically pass through a broader range of costs to their funds, many are revisiting historic assumptions about expense allocation. Market practice has evolved such that allocating a wider range of expenses to the fund is now viewed as commercially acceptable, so long as disclosure is clear and aligned with investors’ expectations and that returns are compelling. Meanwhile, sophisticated investors are benchmarking expense allocation practices across managers, with heightened scrutiny for opaque or inconsistent treatment.

Despite increasing acceptance as a commercial matter, regulatory scrutiny of expense allocation has persisted for more than a decade and is likely to remain a priority in the coming years, particularly for SEC-registered advisers and UK FCA-authorised managers. Enforcement actions and regulatory guidance have focused on expenses not clearly authorised by governing documents or applied inconsistently, as well as overly generic or misleading investor disclosures about expenses.

Practical challenges with certain expense categories

The fundamental principle of most expense allocation policies is the assessment of relative benefits – expenses should be allocated based on whether they primarily benefit the fund or the manager. While some expenses have historically been treated as manager-level (such as office rent and back-office employee compensation), and others as fund-level (such as fund audit and investment-related costs), various mixed expenses sit in a grey zone requiring legal and commercial judgment. These are often the most contentious in investor negotiations and regulatory reviews.

Expense pass-through models historically associated with multi-manager platforms are increasingly influencing the wider market. Many single-strategy managers are now reassessing long-standing assumptions about which costs may appropriately be allocated to funds. That reassessment, however, cannot be driven by economics alone. Broader expense pass-through may be achievable, but only if supported by clear contractual authority, thoughtful application of the relative benefit principle, and disclosure that is specific and consistent across offering documents, internal policies and investor communications.

Research expenses

Research costs span a wide spectrum, including expert networks, conferences, and research-related travel. Increasingly, market data and alternative data subscriptions are also included in this category. Investors often argue that such expenses are inherent to the investment management service already paid for by the management fee, while managers view certain research inputs as directly linked to portfolio decision-making and therefore appropriately borne by the fund. Treatment often depends on strategy – activist, credit, or event-driven strategies may justify comparatively greater allocations of research expenses to the fund than traditional long/short equity strategies, given the intensity of diligence required. Market data and alternative data fees raise similar questions, particularly where specialised datasets are necessary to implement a strategy but also deliver broader firm-wide benefits. In the UK, the debate sits alongside detailed rules on how investment research may be paid for under MiFID II “inducements” regime.

Marketing and investor-related expenses

Marketing costs – travel, gifts, meals and entertainment, and associated regulatory filings or reporting – remain an area of sensitivity. Investors often see these as primarily benefiting the manager, while managers counter that broader distribution helps the fund benefit from economies of scale. SEC exam staff frequently flag instances where managers allocate marketing expenses inconsistently with the governing documents. In addition, placement agent fees continue to require particularly careful handling. In the U.S., institutional investors affiliated with state or municipal governments are frequently prohibited by law from bearing such fees, with potentially serious consequences including legal penalties or mandatory withdrawal.

Third-party consultants

A broader range of consultant costs are now being allocated to funds, especially where a clear nexus to portfolio decision-making can be demonstrated. This allows single-strategy managers to pass through investment-related expenses in a similar manner to multi-manager platforms, but additional disclosure and conflicts issues can arise when consultants are compensated for idea generation. These include fee netting considerations and incentive alignment, whether the consultant’s ideas are exclusive and proprietary to the fund, and issues regarding MNPI. The closer these outsourced functions get to “core” advisory functions, the greater the likelihood of regulatory attention. 

Technology costs

Technology costs – OMS/PMS, modelling tools, terminals, and software development – are among the most challenging to allocate. For systematic strategies such as macro and quant funds, these systems are integral to generating returns and implementing investment strategies. Macro and quant managers have typically treated related technology costs as directly linked to portfolio decision-making. By contrast, investors often analogise core technology infrastructure to staff compensation traditionally borne by the manager. Challenges are particularly acute when engineers design proprietary systems or AI tools that support multiple strategies for the manager. Any shifts in the approach requires clear authorisation in governing documents, and should be supported by written allocation methodologies.

Insurance (D&O / E&O coverage)

Insurance premiums present nuanced allocation issues, particularly where policies provide joint coverage for fund and manager risks. Market practice has evolved toward more granular approaches, with some managers allocating the portion of premiums attributable to fund-specific coverage while absorbing adviser-level protection at the management company. Clear disclosure of allocation methodology and scope of cover remains essential.

Conclusion

The central principle is that expenses should be allocated according to relative benefit, supported by transparent disclosure in governing documents and consistency across investor documentation (offering documents, side letters and DDQs). Managers should maintain a written expense allocation policy that articulates clear and consistent methodologies for mixed-benefit expenses, and should seek to avoid ad hoc allocations whenever possible.