Fee pressure eases on European hedge funds as demand surges

* Performance fee rises for the first time since 2011

* Multi-strategy hedge funds drive the move

* Fees had hit at least a nine-year low in 2013

* Strong capital flows, performance boosts pricing power

By Nishant Kumar

LONDON, July 14 (Reuters) - Pressure on European hedge funds to cut fees is easing for the first time in three years, giving a fillip to managers as they grapple with mounting regulatory and compliance costs.

After hedge fund fees dropped in 2013 to their lowest level since at least 2005, a strong investment performance last year - giving a 9 percent return on average - coupled with increased demand have given those behind new launches the confidence to demand more from investors.

Apart from charging a basic management fee, hedge funds also charge a performance fee based on how well their bets pay off. Both have been under pressure since the financial crisis of 2008-2009 but are showing signs of tentative recovery.

Nearly 200 European hedge funds have launched this year, telling investors that, on average, they would charge a 14.5 percent performance fee, up 50 basis points from 2013, industry tracker Eurekahedge said. Management fees have also risen, to 1.33 percent from 1.2 percent last year, the data - based on figures from 30,200 funds globally - showed.

"The softening in fees that was a function of the post-crisis world has reached some kind of a plateau," said Chris Hawkins, a portfolio manager at fund of hedge funds Gottex.

Granted, the cost of investing in hedge funds remains a key concern for the many pension funds and others, who have channelled billions into the industry in the hunt for less volatile returns and helped push total assets in the sector to a record of nearly $3 trillion.

Hedge fund fees came under scrutiny after the financial crisis, when a large number of funds lost money despite selling themselves to investors as being able to turn a profit in any market environment.

That pushed investors to demand a fee cut, but Europe's funds were particularly hard hit, making the costs associated with post-crisis regulatory changes - particularly an EU directive requiring hedge funds to comply with investment rules and disclosure requirements - more painful.

A 2013 survey by KPMG and industry body AIMA found funds were spending more than 7 percent of total operating costs on compliance, a cost to the industry of more than $3 billion.

The fee uptick detected by Eurekahedge still leaves most managers way below the pre-financial crisis standard of a 2 percent management fee and 20 percent performance fee. But it throws a lifeline to an industry which had seen rising costs and shrinking fees drive many funds out of business.

RISING DEMAND

Investors poured $64 billion into European hedge funds last year after pulling out a net $14 billion in the previous two years, Eurekahedge's data showed. They have added another $31 billion so far this year.

"Against the backdrop of this strong investor demand, select European hedge fund strategies have been able to demand higher incentive fees compared to their peers," said Mohammad Hassan, an analyst a Eurekahedge.

Barring managed futures and macro hedge funds, which bet on broad economic trends and have performed poorly since last year, most of the launches following other strategies have negotiated higher fees on average, compared with last year.

Leading the race to increase fees are European multi-strategy funds, which can invest across asset classes and generated a return of 10 percent on average last year. Nearly 20 such funds have launched this year and said they will demand an average performance fee of 20 percent, nearly double that charged by the 26 launches last year, Eurekahedge said.

Another strategy that has secured higher fees is distressed debt, which involves the purchase of the debt of companies in or near bankruptcy at a deep discount. Five such funds launched in Europe this year, asking on average for a 1.75 management fee and a 20 percent performance fee.

"The strategy mix affects things," Hawkins (NasdaqGS: HWKN - news) of Gottex said. "If you have got a lot of long-duration, distressed-type lock-up funds, they typically are going to charge a higher fee."

With many leading share indexes at record or near record levels and bond yields depressed, Matthew Lamb, head of institutional and fund distribution in the UK at money manager GAM, said investors will pay for managers who are still able to generate returns.

"So it doesn't surprise me to see fees marginally trending up," Lamb said. (Editing by Simon Jessop and David Holmes)