How does the management fee structure of ahedge fund differ from that of an asset manager of a mutual fund?

Question

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Answer 1

The management fee structure for a hedge fund is a combination of a management fee and an incentivefee. For a hedge fund the main difference in the management fee is that it is typically two to four times greatercompared to a mutual fund. More details are supplied below.

Hedge funds differ significantly from mutual funds in terms of fees. 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 charge.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 can be even higher if the manager had an excellent track record. This compares to an average management fee between 0.5% and 1% for mutual funds.

This higher fee for hedge funds makes managing a hedge fund attractive, but it is the incentive fee that makes it a profitable endeavor for good fund managers as this fee can range between 10% to 20% of fund profits. 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, and 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, though as mentioned, these fees can vary among hedge funds.