Hedge funds have long charged the classic “2-and-20” fee (2% of assets plus 20% of profits). In recent years, however, many large multi‑strategy managers (Citadel, Millennium, Point72, Balyasny, etc.) have shifted toward a pass-through expense model. Under this structure the manager often forgoes or reduces the base management fee but charges investors directly for all operating costs – from trader bonuses and data services to travel and office expenses. On paper this yields a low headline fee, but in practice the fund’s “expense ratio” can be much higher. For example, one analysis notes that Dmitry Balyasny’s main fund earned a 15.2% gross return in 2023 but delivered only +2.8% net to investors – with the balance (over $768 million) paid in pass-through fees such as staff compensation, mobile phones, and other overhead. Such models essentially turn hedge funds into expense-heavy vehicles where “clients write a blank check” for costs.
Traditional “2 and 20” vs Pass-Through Fees
Traditional Model: Managers charge ~2% of assets and ~20% of profits. All operating costs are borne by the manager (within reason), so investors know their fee burden upfront. Net performance is simply gross returns minus the 2/20 fees.
Pass-Through Model: Management fees are cut (often to 0–1%), but the fund adds on virtually all expenses. Line items can include portfolio managers’ bonuses, recruitment, office rent, travel and investor entertainment, technology infrastructure, research, legal and compliance costs, etc. In effect, the fund operates like a mutual fund with a high expense ratio. As one industry commentator explains, these major multi-strats “forgo the typical 2% management fee and charge investors the costs of running the show,” covering “everything from trader compensation to mobile-phone service”. Notably, some filings explicitly declare “no limit” on pass-through expenses: Point72’s 2020 offering documents stated that pass-through charges may be unlimited, “[expected to be] substantial regardless of performance”.
Figure: Hypothetical fee breakdown on a $10 bn hedge fund. Under 2-and-20 (2% mgmt + 20% perf), fees are ~$600 m leaving $1.4 bn to investors; under a pass-through structure (0% mgmt + 20% perf + ~6.2% expense ratio) fees rise to $1.0 bn, leaving only ~$983 m to investors. This illustrates how pass-through costs significantly reduce net returns.
Leading Funds and Recent Performance
Despite the cost drag, big multi-strategies have delivered strong gross returns. For example, Citadel’s flagship fund posted a record $16 bn in net profits for investors in 2022 – the largest single-year gain on record. (Bloomberg notes Citadel’s $16 bn net came after roughly $12 bn in expenses and fees.) Along with D.E. Shaw and Millennium, Citadel made multi‑year gains off diverse strategies: LCH research found the three generated about $32 bn in net investor gains in 2022. Similarly, in 2024 Citadel’s $18 bn Wellington fund returned roughly +15.1% and Millennium’s flagship fund about +15.0% (before any investor redemptions).
However, when pass-through costs are deducted, these headline returns shrink dramatically. As noted, Balyasny’s main fund was +15.2% gross in 2023, but just +2.8% net. The same phenomenon affects other firms: hedge-fund analysis shows that multi-strategy managers typically produce very high gross profits but remit a large share to operating expenses. For instance, BNP Paribas reports that in 2023 regular-fee hedge funds delivered about 7.88% net on average, while pass-through-fee peers delivered only 5.98%. In plain terms, pass-through funds kept less than half of what they earned for investors: BNP’s survey found the investors’ share of returns had “dipped below 50%” in pass-through structures, versus much higher retention for traditional models. One report summarizes that multi-strats in 2023 only kept about $0.59 of every $1 they earned (up from $0.46 two years prior).
Key Performance Examples: Citadel’s net $16 bn in 2022 (about a +26% net return on AUM) came after ~$12 bn of fees. In contrast, Balyasny’s 2023 fund turned a 15.2% gross gain into a mere 2.8% net for investors, after $768 m of pass-through charges. This illustrates that gross performance can be misleading – investors should focus on net-of-fees returns.
Fee Structures in Practice
Hedge funds’ offering documents often downplay pass-throughs. A fund may advertise a 1% (or zero) management fee, but a detailed expense list in the fine print reveals dozens of additional charges. Investors need to probe these disclosures. Common pass-through costs include:
Personnel and Compensation: Bonuses and salaries for portfolio managers, analysts and traders. At firms like Balyasny, 80–90% of pass-through fees go to employee pay.
Talent Acquisition: Recruiting and retention costs (sign-on bonuses, temporary staffing, headhunter fees).
Technology and Data: Fees for market data, trading platforms, servers and software. High‑frequency strategies, quants and market-makers demand advanced (and costly) tech.
Research & Dues: Subscription services, industry conferences, legal and consulting fees.
Office and Administrative: Rent, utilities, office supplies, compliance and audit expenses.
Travel & Marketing: Investor roadshows, dinners, travel for fund due diligence and pitches.
Because these items are bundled as “expenses,” investors often underestimate the true fee drag. As one commentator put it, multi-strat firms essentially charge clients “the costs of running the show”. BNP Paribas warned that these hidden charges have grown “for the first time in a decade,” with pass-through funds now keeping barely half of their gross gains. In practice, major managers sometimes revise their fee sheets under pressure – e.g. Balyasny trimmed certain listed expenses in 2024 – but transparency remains limited. Crucially, investors must scrutinize fund documents and fee breakdowns rather than rely on the headline rate. As BNP notes, the effective management fee (including pass-throughs) on some multi-strats can be the equivalent of 3–10% of assets annually, far above the surface “2 and 20.”
Competitive Dynamics: Scale, Talent and Tech vs. Passive Options
Large multi-strategy funds defend their fees by citing scale and sophistication. They argue that only firms with hundreds of traders and massive research budgets (and thus high fixed costs) can generate true alpha across multiple markets. As LCH research observes, Citadel, D.E. Shaw and Millennium combined macro, quant and dispersion strategies to profit “in ways not dependent on rising asset prices,” leveraging their size and diverse teams. Indeed, Citadel has built a $62 bn platform and Ken Griffin’s team continually reinvests in technology and hiring top talent.
Yet this model is increasingly challenged. Smaller hedge funds cannot match that scale and often struggle to charge competitive fees; many have closed or been forced to raise outside capital. Meanwhile, investors have growing low-cost alternatives. Hundreds of ETFs and mutual funds now offer similar market strategies (long/short equity, macro factors, commodities, etc.) for fractions of a percent. One analyst bluntly notes that we live in a world where investors “can access sophisticated strategies via ETFs … for tiny fractional costs,” making it “hard to see how these large multi-strat firms can continue to perform and retain investors with the kind of cost drag these funds experience”. In other words, if passive or single-strategy products can deliver 8–10% net returns on broad markets, it’s increasingly difficult for hedge funds to justify taking >50% of gains in fees.
Takeaways: Institutional investors now demand scrutiny of fee structures. They should:
Analyze Net Returns: Focus on after-fee performance. A fund with stellar gross returns may leave little for investors once pass-throughs bite (as with Balyasny’s 2023 example).
Demand Full Disclosure: Request detailed expense breakdowns. Watch for open-ended clauses (“no limit” pass-through) and ask managers for historical expense ratios.
Compare Peers and Benchmarks: Use research (e.g. BNP Paribas, BarclayHedge, Preqin) to see how much of gross returns peers are retaining. Gauge whether expected net returns justify the fees.
Consider Alternatives: Evaluate if a multi-strategy fund’s promised skill and diversification truly outperform low-cost alternatives. Large firms’ scale and technology may give them an edge, but small funds and indexed products are claiming market share by undercutting fees.
In summary, hedge funds today often pitch a low headline fee but layer on pass-through expenses that can halve investor returns. Recent data show that conventional-fee funds have begun outperforming pass-through peers, underscoring the importance of fee transparency. Savvy investors will dig below the surface “2 and 20” to understand the effective cost of a fund – and weigh it against the net alpha delivered.