What does 'Two And Twenty' mean

Two and twenty is a type of compensation structure that hedge fund managers typically employ in which part of compensation is performance-based. This phrase refers to how hedge fund managers charge a flat 2% of total asset value as a management fee and an additional 20% of any profits earned.

BREAKING DOWN 'Two And Twenty'

The 2% management fee is paid to hedge fund managers regardless of the fund’s performance. A hedge fund manager with $1 billion of assets under management (AUM) earns $20 million even if the fund performs poorly. The 20% profit fee is only paid once the fund achieves a level of performance that exceeds a certain profit threshold, typically around 8%. Some investors, who have never paid the 20% fee because there haven’t been any profits, consider the 2% management fee to be too high relative to the overall performance of many funds.

Famous value investor Warren Buffett has opined in a letter from February 25th, 2017 that " My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused it, in aggregate, to waste more than $100 billion over the past decade. Figure it out: Even a 1% fee on a few trillion dollars adds up. Of course, not every investor who put money in hedge funds ten years ago lagged S&P returns. But I believe my calculation of the aggregate shortfall is conservative." According to Buffett, very wealthy investors are accustomed to superior service and products in other areas of life, and they mistakenly think superior products and services are also available in financial services, which in his view is a mistake. They end of wasting trillions of dollars on overly complex and ineffectual hedge fund strategies. (See also: Warren Buffett's Annual Shareholder Letter for 2017.)

When High Fees Are Justified

One the world’s most successful hedge funds since 1994 has been Renaissance Technologies, led by Jim Simmons, a former NSA code breaker. At $65 billion in AUM, his fund generates $3.2 billion in annual management fees. Because of his remarkable outsized returns over the years, he also charges a 44% profit fee. It is estimated that his hedge fund returned an average 71.8% between 1994 and 2014. The fund's worst performance between 2001 and 2013 was a 21% gain. When asked by investors why his profit fee is so high, he responds by telling them they can leave if they want – but few do.

No Longer Two and Twenty

Due to their underperformance or inconsistent performance, many hedge fund managers have come under pressure to reduce their fees. Investors have been redeeming assets with poor-performing hedge funds at a record pace, with a large portion being reallocated to larger funds with stronger track records. To stop the bleeding, hedge fund managers have been complying. In 2015, the average fee arrangement stands at 1.5% of assets and 17.7% of profits. However, the top-performing hedge funds still charge 20% or more.

Investors are not the only ones complaining about high profit fees. Hedge fund managers are also coming under pressure from politicians who want to reclassify the profit fees as ordinary income for tax purposes. As of 2016, their profit fees, also referred to as carried interest, is classified as capital gains, which are taxed more favorably. Fund managers contend that carried interest is not a salary, but that it is an at-risk return on investment payable based on performance.

RELATED TERMS
  1. Hedge Fund Manager

    A hedge fund manager is an individual who oversees and makes ...
  2. Performance-Based Compensation

    Performance-based compensation is an incentive-based form of ...
  3. Absolute Return Index

    The absolute return index is used to compare the absolute returns ...
  4. Perfect Hedge

    A perfect hedge is a position that would eliminate the risk of ...
  5. Fee

    A fee is a fixed price charged for a specific service and is ...
  6. Total Annual Fund Operating Expenses

    The total annual fund operating expenses for a fund are reported ...
Related Articles
  1. Managing Wealth

    HF Performance Report: Did Hedge Funds Earn Their Fee in 2015?

    Find out whether hedge funds, which have come under tremendous pressure to improve their performance, managed to earn their fee in 2015.
  2. Investing

    What Are Some Reasons to Invest in Hedge Funds Now?

    Financial news has been dominated in recent months by reports of hedge fund struggles. Are there any reasons why investors might consider hedge funds now?
  3. Financial Advisor

    4 Reasons to Still Consider Traditional 2 & 20 Hedge Funds

    Find out why traditional 2 & 20 hedge funds are still worth considering as an investment, even though they have underperformed for the last several years.
  4. Investing

    Investors Are Turning to ETFs Over Hedge Funds

    Exchange-traded funds have grown to surpass hedge funds in total assets, signalling a major shift in investor strategy.
  5. Investing

    What Investment Is Best For You?

    ETFs, mutual funds, hedge funds and advisory firms are just some of the choices to consider.
  6. Investing

    Hedge Fund Returns and Taxes

    Hedge funds purportedly bring large returns, but they also come with large fees and taxes.
  7. Investing

    Why Hedge Funds Do Not Belong in Your Portfolio

    Considering hedge funds as part of your investment strategy? Make sure you understand all the risks and fees involved.
  8. Investing

    Just How Different Are Hedge Fund Investing Strategies?

    Before investing in hedge funds, be sure to consider all the facts.
  9. Investing

    How To Start a Hedge Fund In the United States

    A general overview of how to start a hedge fund firm in the United States, including complying with state and federal regulations.
Hot Definitions
  1. Return On Equity - ROE

    The profitability returned in direct relation to shareholders' investments is called the return on equity.
  2. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  3. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  4. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  5. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  6. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
Trading Center