This article originally appeared in Institutional Investor on June 1, 2018.

Allocators want cheaper fees, but they also want the best managers. They can’t have both — and that’s stalling industry progress when it comes to alignment of interests.

Five years ago, a friend at a large institutional investor spent months alongside a half dozen important allocators creating a wish list of best practices for structuring hedge fund investments. The list included a management fee that covered the cost of business, a performance fee that rewarded alpha and carried a multi-year clawback, and term structure that matched the liquidity of underlying investments. When I asked my friend if his portfolio reflected his wish list, he responded, “Well, no, the managers we want in our portfolio won’t accept these terms.”

The disconnect between the wishes and actions of hedge fund investors makes the industry appear stuck in the mud. In theory, allocators want exactly what my friend sought — cheaper fees and a better alignment of incentives. The mainstream press has made “hedge funds” synonymous with “high-fee investing,” and hedge fund performance over the past ten years has underwhelmed investors. The impetus for change should be at hand.

In practice, however, almost nothing is different. Back in early 2009, The Economist suggested “two and twenty” might become “one and ten.” A look at the data reveals a very different future than that predicted. Industry assets are at an all-time high, topping $3 trillion, and fees have barely budged. The average hedge fund charged a 1.6 percent management fee and 20 percent incentive fee ten years ago, according to industry tracker Preqin. Today, the average fund charges 1.5 percent and 17 percent, a recent Goldman Sachs survey found. Fees are directionally lower, but not by much in the scheme of things.

This contradiction between theory and practice results from hedge fund allocators seeking so-called best-of-breed managers. Industry-wide assets are concentrated in the largest funds. According to Institutional Investor’s latest Hedge Fund 100 ranking, the largest 101 firms together oversee $1.7 trillion; approximately 60 percent of the industry’s assets are controlled by just 1 percent of its managers. Here’s the rub — those funds tend to offer the same fees and structure as they have in the past.

The contradictions don’t stop there:

• An allocator believes his managers are best-of-breed and shuns the average hedge fund return, but allocator portfolios together comprise the industry as a whole.
• An allocator wants to keep a larger share of the gross return pie, but his large managers possess pricing power over him.
• Money piles into the largest funds, but size is the enemy of performance.

Fees and terms generally improve only when an allocator changes his portfolio. New allocations offer the opportunity to strike a better deal in situations where the allocator’s relative bargaining power is strong. Negotiations are the norm when allocating to smaller funds, as the vast majority of the 9,899 or so funds outside of the top 101 are starved for growth and would accept money on more favorable terms to the investor.

That said, changing a portfolio provides its own obstacles for an allocator:

• An allocator views himself as a long-term investor, but portfolio turnover lowers the duration of his relationships.
• An allocator articulated a thesis that led to the creation of the current portfolio.
• Shifting the strategy bucks behavioral bias and introduces job risk.

New launches should be another area in which change occurs. Every year, hundreds of new funds launch and struggle to raise money, affording allocators an opportunity to conduct careful diligence and negotiate with their favorites.

How do allocators address the new launch opportunity set? Michael Gelband’s ExodusPoint Capital and Dan Sundheim’s D1 Capital Partners are launching soon with a reported $8 billion and $4 billion in assets, respectively. Both firms will be vaulted into the upper echelon by size overnight and likely suck up the preponderance of capital dedicated to new launches this year. Morever, both have substantial excess demand despite less favorable terms than the market average. So much for improving terms with new launches.

When you add it all up, it shouldn’t be surprising that incumbent practice will take a long time to change. Ten years from now, I suspect hedge fund industry assets under management will be higher than today, fees will be lower, hurdle rates will be prevalent, and term structures will be better aligned. How we get there from here is anyone’s guess.

Alternatively, maybe the market for hedge funds has become increasingly efficient. Allocators with similar networks, data, and resources draw the same conclusions about the teams most likely to meet their objectives, net of fees. As a result, the big will get bigger and command high fees, and the rest of the industry will get winnowed away.

My friend’s portfolio today is still dominated by funds that incorporate none of the characteristics on his wish list. Investing in highly sought-after hedge funds is a perfectly legitimate strategy, but doing so and simultaneously complaining about fees is an irreconcilable conflict.