Shareholder requirementsĪnyone can invest in a mutual fund. That makes hedge funds extremely expensive relative to mutual funds. Hedge funds typically charge 2% in management fees and an additional performance fee of 20% of the profits. If you're interested in index funds, the fees can be much closer to 0%. Mutual funds charge an expense ratio that usually falls between 0.5% and 1.5%. The asymmetry in the fee (e.g., the fund company can't owe investors for negative performance) leads to more volatile strategies and results on a year-to-year basis. Hedge fund managers are incentivized to maximize returns in order to increase their performance fees. The typical mutual fund has a benchmark index that the fund manager aims to outperform. While both hedge funds and mutual funds pool investors' money and typically buy diversified portfolios, there are a lot of differences between the two investment vehicles. While "2-and-20" has been standard in the industry for some time, hedge funds' underperformance since the 2008 financial crisis has put pressure on hedge fund companies to lower their fees. If the fund does poorly and loses money, there's no additional fee.
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So, if the hedge fund manager does well, and they increase your investment from $1 million to $1.2 million, they'll take another $40,000 (20% of $200,000). The performance fee is usually 20% of profits. Often the fund manager and hedge fund company owner are one and the same. They're directly in charge of each investment decision and the strategies the fund will use.
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The fund manager's job is to develop the investment portfolio and manage inflows and outflows of cash into the fund. This fee goes toward covering the operations of the hedge fund and may be used to directly compensate the fund manager. So, if you invest $1 million, you'll pay about $20,000 as a management fee that year. This fee is based on the net asset value of each investor's shares. Hedge funds typically charge two fees: management fees and performance fees.Ī hedge fund company typically charges a 2% management fee. Operating this way allows fund managers to take more aggressive positions without the need to provide liquidity to the investors at all times. You can only buy in or withdraw during certain periods, and there's often a lock-up period of several months to several years after the initial investment. Investments in hedge funds are often relatively illiquid. Virtually any opportunity to make money is on the table. Managers often use advanced strategies, including leverage, short positions, and derivatives such as options, and they can invest across a wide variety of markets, including stocks, bonds, commodities, real estate, cryptocurrency, and more. Restricting themselves to accredited investors allows hedge funds to take more aggressive approaches to investing since they're not heavily regulated by the SEC like mutual funds. The hedge fund pools money from its limited partners and invests it on their behalf.
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The investors are limited partners while the hedge fund company is a general partner. Hedge funds are structured as limited partnerships. The SEC allows accredited investors to invest in less-regulated securities offerings because it assumes investors with that much wealth will have a level of financial sophistication. An accredited investor is defined as someone with a liquid net worth greater than $1 million or an annual net income greater than $200,000 (or $300,000 with a spouse). Hedge funds limit their participants to accredited investors.