There are several fees associated with hedge funds, but the
exact fees that an investor will encounter varies depending on, 1) the money
manager they use, and 2) the type of investments they end up making. There are
a few fees that are standard to virtually every hedge fund situation, and those
are the management and performance fees that are paid out to the hedge fund
manager.
Remember that there are usually two people (or a person and
a limited liability company) at work together in regards to hedge funds. There
is the investor, who provides the money with which investments are made, and
then the money manager, who is a skilled, sophisticated professional with
specialized experience working with hedge funds. The investor has a “back seat”
role, and simply waits for their profits to come in, while the money manager
manages the portfolio in a hands-on capacity. The money manager must obviously
be compensated for their time and skill.
The compensation/fees that go to the money manager are,
again, the management fee, and the performance fee. The management fee is
usually determined annually, and it varies greatly depending on the type of
hedge fund portfolio, and the money manager’s level of skill. The management
fee is calculated to cover costs of operation, but with bigger and more
sophisticated funds, the management fee tends to increase – as the skill level
of the money manager should be higher too. The management fee is usually around
two percent, but that amount will vary depending on the money manager.
The performance fee is based on profits. Many money managers
will require a twenty percent performance fee, although this number will vary. However,
a performance fee may not always be a flat, across the board eventuality of
hedge funds; if, for example, if a fund fails to make more than its investment
(essentially makes no money, or even loses money), there may not be a
performance fee paid out.
There may be something called a high water mark that comes
into play when a fund has not made money or has taken loss. This high water
mark means that, in many cases, the money manager will not see their incentive
(performance) fee until the fund is seeing profit. It is in the money manager’s
best interest to make the investor as much profit as they can, as they will see
a good deal of their paycheck from profit returns. And no wise investor will
stay with a hedge fund portfolio manager that cannot turn a profit on
investments!
Another fee that some will encounter in dealing with hedge
funds is a withdrawal fee. This may depend on the money manager’s policies; for
example, some managers have limits on how much money can be taken out of a
hedge fund at once, and will charge a withdrawal fee in order to attempt to
curtail frequent withdrawals.
These are just some of the fees that may be associated with
hedge funds. When speaking to a potential hedge fund portfolio manager, enquire
as to their specific fees and practices.
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