The Structure of Hedge Funds

Like private equity funds, hedge funds are typically organized as either limited partnerships or limited liability corporations to protect investors from losses exceeding their initial investment and to avoid double taxation of corporate earnings.

Compensation for hedge fund managers typically is based on two components:

  • A management fee of 1-2% of assets under management
  • An incentive fee of 15-20% of the returns in excess of a pre-determined benchmark. Incentive fees are usually constrained by features such as high-water marks, claw-back provisions and other features.

The high fees earned by hedge fund managers has been widely criticized, particularly when the returns generated include some exposure to beta. Beta can be obtained very cheaply through passive investments such as index funds. However, to the extent that the hedge fund returns offer diversification the fees may simply represent a sort of insurance premium that investors are willing to pay  in exchange for risk reduction.

The investments made by hedge funds are often illiquid, and as such many funds require a lock-up period before investments can be withdrawn. In addition, most funds allow cash inflows and outflows only at specific times (usually quarterly.)

For more information, see all articles on: Active Management, Alternative Assets, Asset Allocation, Hedge Funds, Investment Returns, Portfolio Management

See also:
  • Determinants of Funds of Hedge Funds Performance
  • Due Diligence for Hedge Fund Managers
  • Risk Transparency versus Position Transparency
  • Hedge Fund Fee Equalization
  • Types of Hedge Funds
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