There is no singular, all-encompassing fee associated with hedge funds. The funds span a variety of strategies and different investment types – everything from stocks to startups — and depending on what type of money manager the investor uses, the fees may vary. However, the common fees associated with hedge funds are as follows:
- Management fee – this is basic, and is usually determined annually, though it may be paid out on a monthly basis. It will often be determined by the “two and twenty” (2% and 20%) factor. The “two and twenty” fee factor will apply to both the performance (see below) and the management fee; in such cases, two percent is taken annually from the fund’s net assets, and the twenty percent is taken from the annual profit made on the hedge fund.
- Performance fee (also known as an incentive fee) – this is also a very basic fee that money managers (usually limited liability companies or limited partnerships) require for their services. Be careful to distinguish a performance fee from a management fee; they are two different fees, though they are often seen as a package deal, especially since two and twenty percent scenarios are so common.
- Hurdle rates – this type of fee is sort of the baseline for rates of return. They are used to help determine performance rates, weighing the performance of the hedge fund investment overall against market standards. If hurdle rates are put in place as part of a hedge fund partnership, sometimes the performance fee will not be paid unless the return rate equals or surpasses the standards agreed upon. Hurdle rates were introduced to make certain that compensation will still occur, even if the returns do not exceed investment amounts.
- Withdrawal fees – this is not quite as common as the perfunctory performance and management fees, or even hurdle rates. Withdrawal fees occur when money is withdrawn from a hedge fund (hence the name). There may also be fees for withdrawing over an allotted amount of money, or for withdrawing too soon. Generally, this fee exists to discourage investors from withdrawing funds from the hedge fund frequently.
Keep in mind that every hedge fund situation may be different. The money manager may not charge a two and twenty percent fee for their services and may have alternate rates. Specific questions about a money manager’s fees and practices should be directed to the company. There may also be additional fees not mentioned here. It is important to thoroughly discuss fee practices with partners and companies before making any decisions – and especially before making any investments.
Fees are in place to make sure that the money manager has been compensated for their time, effort, and expertise – and also to help incentive them to make the best possible investments with hedge fund money. The higher the returns, the more money the hedge fund manager will be able to pocket at the end of the day. Successful hedge fund partnerships are beneficial for both parties, though the investor and the money manager play very different roles.