Breaking Down the Payout Structures of Most Hedge Funds

If you were ever wondering how hedge funds make money, then this article is for you.

If you were ever wondering what "2 and 20" or "3 and 50" meant when it came to hedge fund compensation, then you are in the right place.

First off, most hedge funds have both a "management" fee, that they collect regardless of performance, and then they have a "performance" fee.

The "management" fee is normally between 1-3% of the total assets in the fund. So, if you have a million dollars invested in a hedge fund, they are taking between $10k - $30k per year for their "management" fee. This is regardless of whether or not the fund loses or makes money. This management fee goes towards the fixed expenses of the fund; office rent, accountants, computer equipment, etc. As the level of assets in the fund increases, the fund will generate more money in management fees. Obviously there are only so many expenses, so at the very large funds, most of their management fees go towards the bottom line of profits for the hedge fund managers.

Then you have the "performance" fee. This ranges anywhere usually from 10% all the way up to 50% in the case of the best performing funds.

If the fund loses money in a year, then they will generate zero dollars in "performance" fees. If the fund makes $200 million dollars over the course of a year and the fund has a "performance" fee of 50%, then the hedge fund management will book a profit of $100 million dollars, and the investors in the fund will split the remaining $100 million based on the size of their investments.

Normally hedge funds don't allow you to pull your money except for designated "windows" during the year (most funds will allow withdrawals once per year.) This is done so that hedge fund managers won't have to liquidate positions in order to meet redemptions.

Hedge funds offer a potentially lucrative scenario for really good traders, which is why the best of the best normally run a hedge fund. If you have a pool of $50 million dollars and you charge a 33% performance fee, then you have the potential to become very rich, very quickly if you have a good year.

In order to invest in hedge funds, you need to have a net worth of at least a million dollars. The SEC is currently trying to change this to make it more stringent for people to invest in such funds.

Filed under: Hedge Fund News | Stock Market Education | General Knowledge