Although little changed in terms of fees and expenses in the hedge fund industry, performance took a bite out of profits in 2014

The hedge fund industry saw a decline of 29.8% in profitability in 2014, according to Citi’s 2014-15 Annual Hedge Fund Operating Metrics Survey. Citi found that in 2013, profits from the hedge fund industry were $31.2 billion, but in 2014, they fell to just $21.9 billion.

Little change in hedge fund fees

The firm’s analysts found, however, that very little changed within the industry. They did discover a “modest improvement” in operating margins despite there being little to no changes in the management fees Hedge Fundsare charging.

Total fees ranged from 1.55% to 1.73% last year, compared to 2013’s range of between 1.53% and 1.76%. Citi reports that hedge funds with between $7.5 billion and $14 billion in assets under management continued to charge the most in management fees. In 2013, the firm said the biggest hedge funds in their survey, which are those with more than $14 billion in assets under management, were charging the least amount of fees.

However, that changed in 2014, with the smallest hedge funds, or those with an average of $100 million in assets under management, becoming the funds with the lowest fees. Citi researchers said this demonstrates the necessity of the funds to “use economics” to attract funds.

“Not too much should be read into this shift, however, since the changes were so modest as to be statistically insignificant,” they added though.

Little change in hedge fund expenses either

Citi also didn’t find much change in average management company expenses. In 2014, the firm had 149 firms representing $580.9 billion in assets under managementin its data pool. In 2013, the data pool contained 114 firms with $415.2 billion in assets under management. (All graphs are courtesy Citi.)

However, even though Citi expanded its data pool, the firm said there wasn’t much change in operating expenses, as they remained within 7 basis points of where they were in 2013 for all firms that managed more than $350 million in assets.

Smaller hedge funds did see a noticeable decline in expenses though, as they fell from 244 basis points to 224 basis points for this category. Their average headcount remained at 10, although compensation was down in all categories except for compliance in 2014. Third-party expenses also fell, declining 23 basis points, and marketing expenses fell 20 basis points.

However an increase in technology spending partially offset those declines, as it rose 26 basis points.

Hedge fund performance plunges

Citi also found that the performance of the hedge funds in its study fell off “sharply” in 2013 in every tier of fund according to assets under management. Performance ranged from 2.9% to 5.5%, compared to 2013’s 8% to 13% performance.

As a result, the firm expects all hedge fund tiers to see “significantly” lower revenues from performance fees. This will especially impact smaller hedge funds, which Citi analysts believe will see their total performance fee pool fall from $6.7 billion to $2.9 billion in 2014.

Hedge fund industry profits

Based on the findings of the survey, Citi states that small hedge funds will see operating expense shortfalls of about $3.5 billion across the full tier, leaving them with only $2.9 billion in revenues from performance fees. Since all of that is needed to cover the shortfall, they remove it from “any potential measure of industry profits.”

That means there’s $18.3 billion left in their pool, and they expect half of that will be used to cover bonuses for hedge fund employees. The rest of it, they think will be carried forward as profit and thus be taxed at about 20% for capital gains. Their after-bonus, after-tax measure of performance fee profits is $7.3 billion. They combine that with the $14.6 billion they estimate in profits for management fees, thus resulting in their expectation of $21.9 billion in profits for the hedge fund industry, a nearly 30% year over year decline.