2 and 20 (Hedge Fund Fees) (2024)

2% management fee + 20% performance fee

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The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.

Again, the 2% fee is charged on the assets under management regardless of the performance of the investments under the fund manager. However, the 20% fee is only charged when the fund achieves a certain level of profit.

The graphic below should make the compensation structure clear.

2 and 20 (Hedge Fund Fees) (1)

How the 2 and 20 Hedge Fund Fee Structure Works

The 2 and 20 fee structure helps hedge funds finance their operations. The 2% flat rate charged on total assets under management (AUM) is used to pay staff salaries, administrative and office expenses, and other operational expenses. The 20% performance fee is used to reward the hedge fund’s key executives and portfolio managers. This bonus structure is what makes hedge fund managers some of the highest paid financial professionals.

How the 20% Performance Fee is Calculated

The 20% performance fee is the biggest source of income for hedge funds. The performance fee is only charged when the fund’s profits exceed a prior agreed-upon level. A common threshold level used is 8%. That means that the hedge fund only charges the 20% performance fee if profits for the year surpass the 8% level.

For example, assume a fund with an 8% threshold level generates a return of 15% for the year. Then the 20% performance fee will be charged on the incremental 7% profit above the 8% threshold. If the hedge fund manages assets of 10 large investors and makes a sizeable profit, its income for the year may run into millions – sometimes billions – of dollars.

Justification of the 2 and 20 Fee Structure

Some investors consider the common 2 and 20 hedge fund fee structure excessively high. Nonetheless, the industry has generally maintained this compensation structure over the years. It is able to do so primarily because hedge funds have consistently been able to generate high returns for their investors. Therefore, clients have been willing to put up with the fees, even if they consider them somewhat exorbitant, in order to obtain very favorable returns on investment. (ROI)

Renaissance Technologies, a hedge fund managed by Jim Simmons, maintained an average annual return of 71.8% between 1994 and 2015. Its worst year during the period still showed a 21% profit. Because of the high yields delivered to investors, they were willing to pay performance fees up to 44%.

Criticisms Against the 2 and 20 Fee Structure

Both investors and politicians have put hedge funds under pressure for their 2 and 20 compensation structure in recent years. This is largely due to the fact that, in the wake of the 2008 financial crisis, hedge funds – like many other investments – have struggled to perform at optimally high levels. As a result, an increasing number of investors have sought out hedge funds that charge fees lower than the traditional 2 and 20.

Politicians have sought a larger cut of hedge fund profits, seeking to have them taxed as ordinary income rather than at the lower capital gains rate. As of 2018, the hedge fund industry has been able to maintain the lower tax rate, arguing that their income is not a fixed salary and is based on performance.

Alternative Hedge Fund Fees Structures

Some of the alternative fee structures adopted by some hedge funds are as follows:

1. Founders Shares

Startup and emerging hedge funds offer incentives to interested investors during the early stages of their business. These incentives are known as “founders shares”. The founders shares entitle investors to a lower fee structure, such as “1.5 and 10” rather than “2 and 20”. Another option is to use the 2 and 20 fee structure but with a promise to reduce the fee when the fund reaches a specific milestone. For example, the fund might charge 2 and 20 on profits up to 20%, but only charge “2 and 15” on profits beyond the 20% level.

3. Discounts for Capital Lockup

A hedge fund may decide to offer a substantial discount to investors who are willing to lock up their investments with the company for a specified time period, such as five, seven, or 10 years. This practice is most common with hedge funds whose investments typically require longer time frames to generate a significant ROI. In exchange for the longer lockup period, clients benefit from a reduced fee structure.

High Watermark Clause

Most hedge funds include a watermark clause that states that a hedge fund manager can only charge performance fees after the fund has generated new profits. If the fund incurs losses, it must recover the losses before charging performance fees.

Additional Resources

Thank you for reading CFI’s guide on 2 and 20 (Hedge Fund Fees). To keep learning and advancing your career, the additional CFI resources below will be useful:

  • Private Equity vs Hedge Fund
  • Hedge Fund Strategies
  • Exchange-Traded Funds (ETFs)
  • Investing: A Beginner’s Guide
  • See all wealth management resources
2 and 20 (Hedge Fund Fees) (2024)


What is 2 and 20 best explained as with regard to hedge funds? ›

The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.

What is the 2 20 rule in private equity? ›

This is also known as the “2 and 20” fee structure and it's a common fee arrangement in private equity funds. It means that the GP's management fee is 2% of the investment and the incentive fee is 20% of the profits. Both components of the GPs fees are clearly detailed in the partnership's investment agreement.

What is a 2 20 fund fee? ›

VCs often use the shorthand phrase “two and twenty” to refer to the 2% of annual management fees a venture fund might take and the 20% carried interest (or “performance fee”) it would charge.

Which of the following best describes the 2 20 fee that is used by most hedge funds? ›

"Two" means 2% of assets under management (AUM), and refers to the annual management fee charged by the hedge fund for managing assets. "Twenty" refers to the standard performance or incentive fee of 20% of profits made by the fund above a certain predefined benchmark.

What is an example of two and twenty? ›

For an example of how two and twenty works, imagine that you have $2 million to invest. You choose to place that money in a fund charging two and twenty. Over the course of one year, you'll pay roughly $2 million x 2% = $40,000 for the 2% management fee.

What is the 80-20 rule for hedge funds? ›

Hedging Risks

By parking 80% of your funds in relatively safer asset classes, you can balance out the risk associated with diversification. For instance, you can invest 80% of your funds in savings bonds, while 20% can be invested in growth stocks or invest 80% in a retirement account and 20% in a taxable portfolio.

What is the 80-20 rule in private equity? ›

80% of your returns will usually come from 20% of your investments. 20% of your investors will usually represent 80% of the capital. For portfolio companies. 20% of your customers will usually represent 80% of your profits.

How much do hedge funds charge their clients? ›

The fee is typically 2% of a fund's net asset value (NAV) over a 12-month period. A performance fee: also known as an incentive fee, this second fee is viewed as a reward for positive returns. Performance fees are typically set at 20% of the fund's profits.

What is the VC fund structure 2 and 20? ›

The 2 and 20 fee structure is a compensation model commonly used by venture capitalists. It involves a fixed management fee (typically 2% of the total asset value) and a performance fee (usually 20% of the fund's profits) that the VC manager receives.

What is a good fund fee? ›

A reasonable expense ratio for an actively managed portfolio is about 0.5% to 0.75%, while an expense ratio greater than 1.5% is typically considered high these days. For passive funds, the average expense ratio is about 0.12%.

What is a good fee for an investment fund? ›

A general rule—often quoted by advisors and fund literature—is that investors should try not to pay any more than 1.5% for an equity fund. At the same time, small-cap funds usually have higher trading costs than large-cap funds.

Which hedge fund has no management fee? ›

Parplus Partners, which runs a volatility strategy designed to protect investors in down markets, will never charge a management fee, its founder insists. Instead, the hedge fund, the Parplus Equity Fund, only gets paid a performance fee when it beats the Standard & Poor's 500 stock index.

What is the minimum investment for a hedge fund? ›

Hedge Fund Industry at a Glance

Some very wealthy individuals invest in hedge funds. Minimum investments of $100,000 are common, and some require $1 million or more.

Are hedge funds worth it? ›

Hedge funds offer the potential for high returns and diversification benefits, but they also come at the cost of higher fees and less regulatory oversight. As with any investment, you should do your own research to determine whether they make sense for your portfolio.

What is the basic explanation of a hedge fund? ›

Hedge funds are financial partnerships that employ various strategies in an effort to maximize returns for their investors. Unlike mutual funds managers, hedge fund managers have free reign to invest in non-traditional assets and employ risky strategies. The U.S. is home to about 67% of the world's hedge funds.

What is a 1 or 30 hedge fund fee? ›

1 or 30 Structure

With this structure, the goal is for investors to retain 70% of alpha generated by the fund[ii]. A key difference between this structure and other popular ones is the word “or”. By inserting this word instead of “and”, the manager has an objective in mind – 70% of alpha must return to investors.

What is a hedge fund easily explained? ›

A hedge fund is a limited partnership of private investors whose money is pooled and managed by professional fund managers. These managers use a wide range of strategies, including leverage (borrowed money) and the trading of non-traditional assets, to earn above-average investment returns.

Are hedge funds Level 2 assets? ›

Level 2 assets may include debt securities, bank loans, short-term floating rate notes and asset-backed securities, securities held within consolidated hedge funds and certain equity method limited partnership interests in hedge funds valued based on NAV where the Company has the ability to redeem at the measurement ...

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