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Hedge Fund Fee Structure

Starting a Hedge Fund

Hedge Fund Fee Structure

Written by Bobby Jan for Gaebler Ventures

If you are starting a hedge fund, your bread and butter will be the fees that you assess. Choosing the right fee structure is essential for the success of your hedge fund. This article provides an overview of some commonly used fee structure components.

Since hedge funds are unregistered investment companies, your hedge fund's fee structure is practically unregulated, thus giving you an enormous amount of freedom to assess fees on investors.

You must, however, disclose your fee structure in advance. If you don't know where to start, here is an overview of some commonly used fee structure components:

Management Fee

Almost all hedge funds charge a management fee. The fee is typically between one and two percent of the asset under management per year. It is typically assessed many times a year to help cover the cost of running a hedge fund. For example, if a fund assesses a management fee 10 times a year, you will take out (asset value under management less liability)*(0.02)/(10) in management fee every time the fee is assessed. Some hedges, however, only charge clients as much as they use toward covering operational expenses.

Performance Fee

This is also known as an incentive fee. Like the management fee, almost all hedge funds assess a performance fee as a component of their fee structure. Typically, this fee is 20 percent of returns. For example, if a one-billion dollar fund gained 30 percent a year and charges a 20 percent performance fee, then this fee amounts to ($1 billion)*(30%)*(20%)=$60 million dollars. As you can see, this is the most exciting fee in the hedge fund industry. Hedge funds with good records and high returns may charge substantially more.

The following fees are less universal than the management and performance fee:

Surrender Fee

This fee is assessed as a percentage of the amount of redemption requested by an investor. Sometimes, this fee is put back into the fund to compensate other investors for the cost of liquidating assets in order to meet the redemption. This fee discourages investors from pulling out of the partnership.

Hurdle Rate

This sets a rate below at which no incentive fees are collected. For example, if the hurdle rate is five percent, then a performance fee is collected only on returns that exceed five percent.

High-Water Mark

This protects investors from paying excessive and redundant performance fees. A high-water mark limits or eliminates the performance fee for making back a loss. For example, you launched a one-billion dollar fund. One year later, the fund grows to $1.3 billion, which gives you a nice performance fee. However, if the fund drops back to one-billion, you will not be able to collect a performance fee or bring the fund back up to $1.3 billion.

Lookback

This is not a typical component in most hedge fund fee structures. Lookback refunds a portion of the performance fee to investors if a loss is taken shortly after the performance fee was assessed.

Cheng Ming (Bobby) Jan is an Economics major at the University of Chicago who has a strong interest in entrepreneurship and investing.