Complete Guide To Investment Companies, Funds And REITs

AAA

Hedge Funds - Fees

Hedge funds also differ quite radically from mutual funds in how they charge fees. Their fee structure is one of the main reasons why talented money managers decide to open their own hedge funds to begin with. Not only are the fees paid by investors higher than they are for mutual funds, they include some additional fees that mutual funds don't even charge.

Management Fee
The management fee for a hedge fund is for the same service that the management fee covers in mutual funds. The difference is that hedge funds typically charge a management fee of 2% of assets managed and in some cases even higher, if the manager is in high demand and has had a very good track record. This fee alone makes managing a hedge fund attractive, but it is the next fee that really makes it a profitable endeavor for good fund managers.

Related Reading:

Incentive Fee
Most if not all hedge funds charge an incentive fee of anywhere between 10 to 20% of fund profits and some hedge funds have even gone as high as 50%. The idea of the incentive fee is to reward the hedge fund manager for good performance; if the fund's performance is attractive enough, investors are willing to pay this fee. For example, if a hedge fund manager generates a 20% return per year, after management fee, the hedge fund manager will collect 4% of those profits, leaving the investor with a 16% net return. In many cases, this is an attractive return despite the high incentive fee, but with more mediocre managers entering the industry in search of fortune, investors have more often than not been disappointed with net returns on many funds.

There is one caveat to the incentive fee, however. A manager only collects an incentive fee for profits exceeding the fund's previous high, called a high-water mark. This means that if a fund loses 5% from its previous high, the manager will not collect an incentive fee until he or she has first made up the 5% loss. In addition, some managers must clear a hurdle rate, such as the return on U.S. Treasuries, before they collect any incentive fees.

Hedge funds often follow the so-called "two and twenty" structure, where managers receive 2% of net asset value managed and 20% of profits, although these fees can also vary among hedge funds.

Hedge funds generally follow one of two types of structures: the first is a traditional hedge fund and the second is a fund of funds. A fund of funds is a hedge fund that holds a diversified portfolio of investments in other hedge funds.

Funds of funds are well-diversified investment vehicles made up of a variety of other funds. They typically have lower minimums and are a good way to invest in hedge funds with broad diversification. Some funds of funds invest in hedge funds with a variety of different strategies and a much higher level of diversification, while others, called single-strategy funds, will invest in a variety of funds having the same or similar strategies.

Fund of funds enable an investor to obtain instant diversification in a portfolio of hedge funds, which is particularly attractive for an investor with a portfolio that is large enough to invest in hedge funds, but too small to achieve proper diversification going directly into hedge funds. For example, with hedge fund minimums often starting at $1 million, it would be difficult for an investor with a $2 million account to diversify their portfolio of hedge funds. The maximum number of hedge funds they could invest in is two and that would not be a very prudent diversification strategy. A fund of funds, however, that is invested in 15 to 20 hedge funds and has a minimum investment of $500,000 enables the investor to gain exposure to the alternative asset class, without compromising the overall struct. There are advantages and disadvantages to funds of funds and the benefits to an investor are completely dependent on the investor.

These multi-strategy funds provide broader diversification and uncorrelated returns within underlying funds. The investor in this case relies on the skill of the fund manager to allocate the portfolio to appropriate strategies and to monitor and tactically adjust the portfolio as needed. An investment in a quality multi-strategy fund of funds is also appropriate for investors who do not have the skill or resources to determine which strategies are attractive in the current environment.

Types Of Hedge Funds
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI Emerging Mkts

    Learn more about the PowerShares FTSE RAFI Emerging Markets ETF, a fundamentally weighted fund that tracks emerging market equities.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares Cali AMT-Free Muni Bond

    Learn more about the iShares California AMT-Free Municipal Bond exchange-traded fund, a popular tax-advantaged ETF that dominates its category.
  3. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Dividend

    Learn more about the SDPR S&P Emerging Markets Dividend Fund, a yield-focused exchange-traded fund tracking global emerging economies.
  4. Mutual Funds & ETFs

    ETF Analysis: First Trust Dow Jones Global Sel Div

    Find out about the First Trust Dow Jones Global Select Dividend Index Fund, and learn detailed information about characteristics and suitability of the fund.
  5. Mutual Funds & ETFs

    ETF Analysis: U.S 12 Month Natural Gas

    Learn about the United States 12 Month Natural Gas Fund, an exchange-traded fund that invests in 12-month futures contracts for natural gas.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Floating Rate Bond

    Explore detailed analysis and information of the iShares Floating Rate Bond ETF, and learn how to use this ETF as a defense against rising interest rates.
  7. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Short S&P500

    Find out information about the ProShares UltraPro Short S&P 500 exchange-traded fund, and learn detailed analysis of its characteristics and suitability.
  8. Mutual Funds & ETFs

    ETF Analysis: SPDR Barclays Investment Grd Fl Rt

    Learn more about the SPDR Barclays Investment Grade Floating Rate Fund, which tracks an index of highly rated floating debt securities.
  9. Mutual Funds & ETFs

    ETF Analysis: ALPS Medical Breakthroughs

    Learn more about a unique and innovative exchange-traded fund (ETF) in the biotechnology industry: the ALPS Medical Breakthroughs Fund.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Healthcare

    Learn about the iShares U.S. Healthcare exchange-traded fund, which invests in a wide range of health care providers, hospitals and home care facilities.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Real Estate Investment Trust - ...

    A REIT is a type of security that invests in real estate through ...
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  5. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  6. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
RELATED FAQS
  1. Can mutual funds outperform savings accounts?

    A mutual fund can – and should – outperform a savings account. In most cases, it should not even be a close race. Savings ... Read Full Answer >>
  2. Can mutual funds invest in private companies?

    Mutual funds can invest in private companies, which may come as a surprise to many investors. It is rare for a fund to have ... Read Full Answer >>
  3. Where do penny stocks trade?

    Generally, penny stocks are traded through the use of the Over the Counter Bulletin Board (OTCBB) and through pink sheets. ... Read Full Answer >>
  4. Where can I buy penny stocks?

    Some penny stocks, those using the definition of trading for less than $5 per share, are traded on regular exchanges such ... Read Full Answer >>
  5. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  6. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!