Key Takeaways
- • Teacher Retirement System of Texas ($133 billion AUM) pioneered a 1-or-30 fee model to replace traditional 2-and-20 structures, targeting a sustainable 70-30 alpha split between investors and managers across market cycles.
- • Brad Gilbert, TRS director of hedge funds, identified a structural problem: in low-return environments, managers were capturing 50-75% of alpha versus the desired 30%, making traditional fee arrangements unsustainable for institutional investors.
- • The new fee model gained acceptance from the majority of TRS' hedge fund managers; approximately two-thirds of the fund's hedge fund allocations now operate under revised fee structures, according to CIO Jase Auby.
- • TRS' approach influenced peer institutions and positioned the fifth-largest U.S. pension fund as a leader in renegotiating hedge fund economics, addressing a widespread problem faced by CalPERS, NYC ERS, and other large investors.
- • The initiative solved for a specific outcome: guaranteeing investors 70% of alpha regardless of market conditions, forcing managers to align fee structures with performance rather than asset base.
Summary
In early 2017, the Teacher Retirement System of Texas became a catalyst for structural reform in hedge fund fee negotiations, addressing a problem that had plagued large institutional investors for years. With $133 billion in assets under oversight, TRS identified a fundamental misalignment in hedge fund economics: as gross returns declined across the industry, net returns for investors deteriorated sharply due to traditional 2-and-20 fee structures (2% management fee, 20% performance fee) that prioritized manager compensation over investor outcomes.
Brad Gilbert, director of hedge funds at TRS, articulated the core issue with precision. The pension fund's investment philosophy held that alpha should be split 70-30 in favor of investors across both bull and bear markets. However, in the low-return environment that had persisted through recent years, actual alpha splits had inverted, with managers capturing 50-75% of returns while investors kept only 25-50%. "If the manager is earning 8 to 10 percent net annual returns, 70-30 is about the split. But in the last few years, 50 to 75 percent has been going to the manager, and we feel like that's not a split that is sustainable to the industry," Gilbert stated.
Rather than exiting hedge funds entirely—as CalPERS and NYC ERS had done—TRS developed an alternative fee model designed to preserve the 70-30 split regardless of market conditions. The resulting "1-or-30" structure adjusted management fees and carried interest in a way that guaranteed investors received 70% of alpha in any environment. After successfully negotiating this arrangement with an existing manager, TRS refined the approach and gained acceptance from the majority of its hedge fund partners. According to CIO Jase Auby, approximately two-thirds of TRS' hedge fund managers had adopted revised fee structures aligned with this principle by the reporting period.
Jonathan Koerner, head of implementation at hedge fund consultant Albourne Partners and a former asset allocation professional at Utah Retirement Systems, confirmed that TRS "negotiated a great deal" with its initial pilot manager, establishing proof of concept for a scalable model. The initiative positioned TRS as an institutional leader capable of reshaping industry standards, demonstrating that large, sophisticated investors could force alignment between manager and investor interests without abandoning the asset class entirely.
Brad Gilbert, director of hedge funds at TRS, articulated the core issue with precision. The pension fund's investment philosophy held that alpha should be split 70-30 in favor of investors across both bull and bear markets. However, in the low-return environment that had persisted through recent years, actual alpha splits had inverted, with managers capturing 50-75% of returns while investors kept only 25-50%. "If the manager is earning 8 to 10 percent net annual returns, 70-30 is about the split. But in the last few years, 50 to 75 percent has been going to the manager, and we feel like that's not a split that is sustainable to the industry," Gilbert stated.
Rather than exiting hedge funds entirely—as CalPERS and NYC ERS had done—TRS developed an alternative fee model designed to preserve the 70-30 split regardless of market conditions. The resulting "1-or-30" structure adjusted management fees and carried interest in a way that guaranteed investors received 70% of alpha in any environment. After successfully negotiating this arrangement with an existing manager, TRS refined the approach and gained acceptance from the majority of its hedge fund partners. According to CIO Jase Auby, approximately two-thirds of TRS' hedge fund managers had adopted revised fee structures aligned with this principle by the reporting period.
Jonathan Koerner, head of implementation at hedge fund consultant Albourne Partners and a former asset allocation professional at Utah Retirement Systems, confirmed that TRS "negotiated a great deal" with its initial pilot manager, establishing proof of concept for a scalable model. The initiative positioned TRS as an institutional leader capable of reshaping industry standards, demonstrating that large, sophisticated investors could force alignment between manager and investor interests without abandoning the asset class entirely.
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