A hedge fund begins with the person who serves as the general, or managing, partner of the limited partnership that forms the structure of most hedge funds. This is the person who makes the actual investment choices and decisions for the fund.
They aretypically an established investment advisor with a proven track record in managing investments and/or a unique, appealing investment strategy. This individual, sometimes with the assistance of some of the initial investors, seeks out potential investors to persuade them to invest in the fund.
Once a fund has accumulated investment dollars it earns money based on assets under management (AUM) as well as on fund performance. The more investment money a hedge fund can accumulate, and the better it performs, the more money it makes for itself.
Key Takeaways
- Hedge funds seem to rake in billions of dollars a year for their professional investment acumen and portfolio management across a range of strategies.
- Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM).
- Funds typically receive a flat fee plus a percentage of positive returns that exceed some benchmark or hurdle rate.
- Hedge fund marketing is a key method of bringing in new investor dollars, which adds to the fund's bottom line.
How a Hedge Fund Raises Money
A hedge fund raises its capital from a variety of sources, including high net worth individuals, corporations,foundations,endowments,and pension funds. Hedge funds do not usually look for individual small investors such as the average person who purchases shares in a mutual fund, but instead seek out investors with large amounts of investment capital with whom to form a limited partnership.
A large part of raising investment funds for a hedge fund depends on the initial performance of the fund manager. To get the fund started and establish an investing track record, the fund manager usually invests a substantial amount of his or her own money into the fund. If the fund manager performs exceptionally well, showing excellent returns on investment, the fund then begins to attract the attention of large institutional investors who have substantial amounts of capital available to invest.
Good performance is also likely to elicit investment of additional capital from initial investors. The keys to raising investment capital for a hedge fund are for the fund manager to be able to find and convince some initial investors of his or her ability to manage the fund profitably, and then proceed to do just that so the fund attracts additional investors in the future.
Hedge Fund Fee Structure
Two and twenty (or "2 and 20") is a popular fee arrangement that is standard in the hedge fund industry and is also common in venture capital and private equity. Hedge fund management companies typically charge clients both a management and a performance fee. "Two" means 2% ofassets 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. While this lucrative fee arrangement has resulted in many hedge fund managers becoming extremely wealthy, in recent years thefee structurehas come under fire from investors and politicians for varying reasons.
Two and twenty is less so the norm in the industry thanks to hedge funds offering better arrangements. As well, robo-advisors charge as little as 0.25% of total assets for managing capital and no additional fees for profits gained.
Some hedge funds also have to contend with ahigh watermarkthat is applicable to their performance fee. A high watermark policy specifies that the fund manager will only be paid a percentage of the profits if the fund's net value exceeds its previous highest value. This precludes the fund manager from being paid large sums for poor performance and ensures that any losses must be made up before performance fees are paid out.
Hedge Fund Marketing
Hedge fund managers are hampered in their efforts to raise funds by regulations that prevent them from publicly advertising a specific fund. They can, however, do things such as set up aninformational website that explains their investment strategies and provides information on their backgrounds and experience as investors, investment advisors, or money managers. Fund managers often seek publicity by offering specific trading ideas on investment websites.
Hedge funds are often marketed by the fund manager who networkswith friends or business acquaintances or through third-party placement agents, who are individuals or firms that act as intermediaries for asset managers such as pension fund managers or investment managers for a foundation or endowment.
Sometimes fund managers offer "seed investment arrangements" to initial investors.In exchange for a substantial investment in the fund, the investor receives a discount on fund management fees or a partial ownership interest in the fund. These initial investors often do their own networking to solicit other investors.
Hedge fund managers mayproduce some basic marketing materials to give prospective investors. Such material, referred to as a "pitch book" or "tear sheet," contains information on the fund's strategy, the fund manager, and an outline of the terms for investing in the fund.
FAQs
A hedge fund raises its capital from a variety of sources, including high net worth individuals, corporations, foundations, endowments, and pension funds.
How do hedge funds get their money? ›
Hedge fund strategies involve investing in debt and equity securities, commodities, currencies, derivatives, and real estate. Hedge funds are loosely regulated by the SEC and earn money from the 2% management fee and 20% performance fee structure.
Who raises capital for hedge funds? ›
A hedge fund is an investment fund that pools capital from accredited investors or institutional investors and invests in a variety of assets, often with complex portfolio-construction and risk-management techniques.
Where do hedge funds borrow stocks from? ›
In this case, a securities company - typically a brokerage firm - will lend some securities or some cash to the hedge fund and will hold other assets in the fund's account as collateral for the loan.
What is the capital requirement for a hedge fund? ›
1 2 Hedge fund general partners and managers often create high minimum investment requirements. It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate.
Why are hedge fund owners so rich? ›
Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark. For example, let's say a hedge fund manages $1 billion in assets. It will earn $20 million in fees.
How does the world's largest hedge fund make its money? ›
According to a person briefed on the investigation, what they concluded, in part, was that the world's biggest hedge fund used a complicated sequence of financial machinations — including relatively hard-to-track trading instruments — to make otherwise straightforward-seeming investments.
Who owns the biggest hedge funds? ›
Bridgewater Associates
Westport, Conn. Westport, Conn. In 1975, Bridgewater Associates was founded by Ray Dalio in his Manhattan apartment. Today Bridgewater is the largest hedge fund in the world and Dalio has a personal fortune of approximately $19 billion.
Who are the richest hedge fund managers? ›
Who Is the Richest Hedge Fund Manager? Ken Griffin of Citadel is both the richest hedge fund manager and the highest paid. In 2022, he earned $41. billion, and by the beginning of 2023 his net worth was estimated at $35 billion.
Does Bill Gates invest in hedge funds? ›
Although he doesn't manage a public company or hedge fund like Buffett and Griffin do, he's donated a boatload of money to the Bill & Melinda Gates Foundation Trust. And over half of this charitable foundation's $42 billion portfolio is invested in these three dividend stocks.
Hedge funds also come with the stipulation that any losses must be recouped for investors before the manager can take the 20% fee. This is known as the funds high water mark.
Where do hedge funds buy data from? ›
Data sources like credit card transactions, geolocation data, geospatial data, and internet search histories started playing a crucial role in informing investment decisions. These alternative data sources gave hedge funds a more granular view of consumer behavior and market trends, often in real-time.
Do banks loan money to hedge funds? ›
Investors do not always get a return, but the bank will get its money one way or the other through offering leverage. The things are different. If a bank lends money to a hedge fund it will take collateral and as such it is a very low risk way to make money.
Who Cannot invest in a hedge fund? ›
You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Is BlackRock a hedge fund? ›
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
What is the 2 20 rule for 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.
Do hedge funds use their own money? ›
Hedge funds primarily raise capital from external investors for several reasons, rather than relying solely on their own capital: Leveraging Investment Potential:By raising capital from external investors, hedge funds can significantly increase their investment potential.
How do hedge funds make money from failing companies? ›
Hedge funds that invest in distressed debt purchase the bonds of firms that have filed for bankruptcy or are likely to do so in the near future. Hedge funds purchase these bonds at a steep discount of their face value in the anticipation that the company will successfully emerge from bankruptcy as a viable enterprise.
How much do hedge funds make a year? ›
While ZipRecruiter is seeing annual salaries as high as $122,000 and as low as $11,000, the majority of Hedge Funds salaries currently range between $51,000 (25th percentile) to $100,000 (75th percentile) with top earners (90th percentile) making $114,000 annually across the United States.
What percentage of profits do hedge funds take? ›
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.
