| The Big Take

Hedge Funds Are Pocketing Much of Their Clients’ Gains With ‘No Limit’ Fees

By Hema ParmarWeihua LiKyle KimArmand Emamdjomeh Published: February 10, 2025 | Updated: February 11, 2025

In 2023, the main hedge fund at billionaire Dmitry Balyasny’s eponymous firm notched a gross return of 15.2%.

Investors walked away with a gain of just 2.8%.

The rest they paid in fees — more than $768 million — mainly for compensation but also a wide variety of other costs down to mobile-phone service.

That parceling out of costs is one of the most coveted perks of running a multistrategy hedge fund. Investors are so eager to pony up money that they effectively write a blank check, agreeing to cover just about any expense managers deem reasonable, in good times and bad.

The term for that: Passthrough fees.

For some, the fees appear outrageously high. “Passthroughs are wild. You are paying for everything including the copier paper,” said Joe Reilly, chief executive officer of family office network Circulus Group.

Yet others view it as an acceptable trade-off for more reliable performance. They’re willing to shake off weak years, like Balyasny’s performance in 2023 — which the firm calls “an anomaly in our 24-year history.”

Multistrats — known for their trading “pods” that chase profits in all kinds of markets — say they need that freedom to compete for talent, invest in cutting-edge technologies and stay nimble as markets evolve. Prominent firms with the fee structure include Millennium Management, Citadel, Point72 Asset Management, Balyasny Asset Management and ExodusPoint Capital Management. Those five alone manage more than $200 billion.

A Bloomberg analysis of the group’s regulatory filings shows their publicly disclosed lists of expenses eligible to pass through have exploded in recent years. A decade or so ago, they typically called out run-of-the-mill categories like compensation, rent and computers. Now, some firms specify that fees may include artificial intelligence, compliance costs, internal referral payments, the expense of terminating staff and catch-all items — like “extraordinary or non-recurring expenses.”

Altogether, the group’s list of potential expenses has increased by almost 40% since 2018.

There are several reasons why firms are disclosing more expenses, according to people close to hedge funds.

The appearance of a new item may mean it wasn’t previously passed through, that an existing cost has swelled or that clients have asked about it. Some firms may have erred on the side of disclosing more to avoid running afoul of tougher regulatory oversight, especially during the Biden administration.

The filings also hint at other changes. For example, some money managers have honed their descriptions of who might get paid with investor cash. In 2023, Ken Griffin’s Citadel tweaked its description of passthrough fees to note they also cover “third-party consultants/contractors.” That outsourcing saves investors money, a person close to the firm said, asking not to be named because such information is confidential.

Last week, Citadel issued a bond prospectus, obtained by Bloomberg, with pages of details on costs it charges. They include technology and travel “of all forms,” such as booking or leasing a private jet. Investors can also foot bills for employee gifts, entertainment for employee gatherings, as well as snacks, drinks and “other nourishment,” the document shows.

From the start of 2022 and through last September, Citadel’s three biggest funds racked up almost $12.5 billion of passthrough fees, with more than $11 billion paying for employee compensation and benefits.

Last year, Point72 told investors they will now pay for certain costs that founder Steve Cohen once covered. The change was expected to shift hundreds of millions of dollars in costs to clients. The firm uses a partial-passthrough structure, with many back-office expenses covered under a fixed-management fee.

Passthrough fees are so expansive that the youngest of the five firms, ExodusPoint, recently tried a new approach. It now lists seven things the fees won’t cover. They include artwork.

‘No Limit’

How much firms may spend on approved items is another matter.

“There is no limit on the amount of passthrough expenses that may be charged,” Point72 wrote in a 2020 filing, the first year it used that language. The fees are generally expected to increase as fund performance improves. But they “are expected to be substantial regardless of the performance.”

One industry study shows that the portion of gross returns shared with clients is shrinking. Multistrats kept 59 cents of every dollar they made for investors in 2023, according to a BNP Paribas report. That was up from 46 cents two years earlier.

The result is that passthrough fees exceed the hedge fund industry’s traditional “2-and-20” structure that has itself long been seen as rich. Under that framework, firms take 2% of client assets to cover basic operational costs, plus 20% of profits generated. Some multistrat clients estimate they effectively pay anywhere from 7-and-20 to 15-and-20.

Last year, for example, ExodusPoint handed investors an 11% gain after charging 8.4 percentage points in passthrough fees, meaning clients received about 57% of the year’s haul. The returns, as well as those for Balyasny, were described by people with direct knowledge of the figures.

The various fees add up. Since 1969, hedge fund managers globally have pocketed roughly $1.8 trillion in total fees — almost half of the industry’s gains, according to fund-of-hedge-funds LCH Investments.

Representatives for Millennium, Point72 and ExodusPoint declined to comment for this story. Balyasny said it has a long history of delivering consistent double-digit returns.

“As in any business, when revenues are below expectations, expense ratios will be higher,” it said of its lackluster 2023. “We addressed the issues and had a strong 2024 with performance and net margin returning to target.”

Citadel said it has used the fees to invest in people, technology and infrastructure to create a “winning franchise” that has lasted more than three decades. “Principals and employees, who are the largest investor in the Citadel funds, also pay the same fees and expenses as external investors, ensuring an exceptionally strong alignment of interests,” the firm said.

For investors, agreeing to pay passthrough fees is a bet that the firm will produce such an exceptional gross return that the costs won’t hurt. In fact, the industry even points to studies suggesting that the higher the passthrough fees, the better the end result is for investors.

Take, for example, Citadel’s gross return of 60% in 2022. Though fees ate up more than a third of that, clients still reaped a 38% gain — a knockout year for any hedge fund making diversified bets. The S&P 500, meanwhile, fell more than 19%.

Broadly, clients expect multistrats to generate steady returns of at least 12% annually with few downswings. For most firms, it’s rare to hand customers single-digit returns, such as Balyasny did in 2023. All five funds have avoided any down years over the past half-decade.

That’s why so many investors are willing to lock up their money, even as Treasuries yield more than 4% and S&P 500 index funds soar.

Passthroughs help the firms recruit armies of highly talented pods that bet on tens of thousands of securities, reducing net risks, said Justin Young, director of investments at Multilateral Endowment Management Co. Firms can also set up infrastructure to keep trading costs low and provide additional cash at key moments to ramp up winning bets.

“This approach has delivered far more diversification, capital efficiency, downside protection and higher returns,” Young said. “They aren’t really comparable to your typical long/short equity fund that has 20 stocks in a single sector. The fees reflect this.”

The five firms are part of a much broader landscape of multistrats, including many smaller and newer managers. More than 80% of such firms have some sort of passthrough structure, research from Goldman Sachs Group Inc. shows.

One concern is that multistrats with thinner track records may struggle to generate high enough returns to cover hefty expenses, tempting their managers to take even bigger risks to reverse their fortunes — like an unlucky gambler doubling down at the card table, hoping to get their money back, according to a senior Wall Street executive. In fact, the heavy use of leverage by multistrats is already on regulators’ minds, with Bank of England Governor Andrew Bailey warning this week about the possibility that such firms may one day have to rush for the exits in a group.

Read More: Multi-Manager Hedge Funds Pose Stability Risk, Says BOE’s Bailey

Another worry is that managers who do generate windfalls may spend more than necessary on perks.

That poses a reputational risk for pensions, philanthropies and other institutions under public scrutiny to agree to passthrough fees, said Scott Radke, CEO of New Holland Capital, which allocates to hedge funds and runs a multistrat that charges partial passthroughs.

“It can be embarrassing for a pension fund to be paying for lavish office space and other non-investment-related expenses for wealthy hedge fund managers,” Radke said. While some costs are widely accepted as necessary, “there’s some other things that can seem miscellaneous or luxurious.”

The amount of detail provided by individual hedge funds runs the gamut. Citadel and Millennium’s annual filings have consistently used catch-all phrases to describe what their passthrough fees cover — essentially saying investors pay all costs related to a fund. At the other end of the spectrum, ExodusPoint ticks off more than 100 types of expenses.

Though regulatory filings show the types of items charged to investors, it remains less clear how much each one costs. Investors get only periodic breakdowns of expenses lumped into broad categories such as compensation, technology and travel.

To learn more, an investor may set up a call with the hedge fund. Clients say those conversations can be subject to preexisting non-disclosure agreements.

Some hedge fund investors may not realize what they’re signing up for. Much of the industry is moving downmarket, reeling in smaller customers. A growing throng of wealthy individuals, like doctors or lawyers, now use their banks’ investing platforms to find hedge funds.

But big institutions are paying closer attention.

Blackstone Inc., with an internal database of almost 100 funds that pass through fees, ran an analysis. It found that on average, passthrough fees amount to about 6.5% of a fund’s assets, with the most expensive managers reaching the high-teens, David Ben-Ur, who helps oversee Blackstone’s investments in external hedge funds, said at a Bloomberg conference in June.

The fees have been compounding at an annual growth rate in the “high-single digits” over the past five years, Ben-Ur said.

It’s all the more unsettling when clients — known as limited partners — can’t tell exactly how all of that money gets spent, said Radke.

“The fact that it is opaque on what exactly is passed through,” he said, “makes LPs suspicious about what they’re paying for.”

Updates with Bank of England governor's warning and chart showing hypothetical fees for a 20% return.