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Sooo... what happens if the returns are negative? Does the fund manager cop 20% of the loss?

What happens if the gross return is 2.5%? Does the fund manager still get everything (2% fee plus 20% of the 2.5% gross)...?

Clearly if the returns are between 0 and 2% the fund manager wins and the investor loses. Seems to be open to all kinds of gaming of the system.

This is exactly the rub. Managers take no haircut when the fund gets hammered. It is true that most managers won't take a profit on investor's money until they return to the "high water mark" of how much $$$ that investor originally put into the fund, but often times when a fund loses too much money, the manager simply closes it and opens another, therefore dodging the high water mark requirements.

But honestly, if rich people can't figure out that their fund manager is ripping them off, then to hell with them. Fund managers, at least, prey on people who are already rich. Better than a lot of other sleazes who take advantage of the undereducated and poor. I'm not saying it's right, I'm just saying that if you have enough money to write John Paulson a check, then you should know what you're doing. I can't say the same for an old woman in a bad neighborhood who was talked into refinancing her house of 50 years so she could take out cash to buy a conversion van. The people who preyed on her are far worse, in my mind, than your average fund manager who does nothing of virtue for his clients.

I completely agree. At least in the hedge fund world, they have to work hard to get in the money. [They can't advertise in traditional media.]

Managers take no haircut when the fund gets hammered

Which is exactly why I think carried interest should be taxed as ordinary income.

/soapbox

People (and actually it's institutions, mostly) who invest in hedge funds are sophisticated investors. They know full well what the managers are being paid and presumably feel they are worth it.

They were back when they were regularly producing 12-20% returns. That hasn't been the case for years. I can't imagine why anyone is still in a 2/20 hedge.

Ha ha. Good one. What are you basing this on?

The fact that they keep their money with the manager? Sure there might be a few people who don't know what they are doing (lottery winners?) but if you have enough money to buy into a hedge fund, you more than likely are paying attention.

I don't see why you think A applies B at all here. I have worked both in institutional investment and in a hedge fund, and it's pretty fucking hard to read a term sheet for anybody.

I don't know who downvoted you but that's a valid question.

No, if the fund doesn't make money, they don't get performance fee NOR do they have to take 20% of the loss.

Also, the 20% performance fee is applied on the 'Net Gain' and not gross return.

E.g. Going back to my example, if hedge fund made, 10MM on 100MM assets. They will first pay themselves 2MM and charge 20% performance fee on 8MM and not 10MM.

Again, investors are not stupid either, if the hedge fund can't show them gains, they will take their money somewhere else. [Obviously they can still become victim to Madoff like outright fraud.]

>Does the fund manager cop 20% of the loss?

Of course not. This idea that the person who carries the most (financial!) risk gets the biggest pay off rarely actually exists in the real world.

It's a big market. http://www.hedgefundsreview.com/hedge-funds-review/news/1938...

Indeed it's not at all unreasonable that the largest firm would be < 1% of the market.

In fact it's fairly logical, given that:

A) hedge funds are pursuing strategies where the individual investment opportunities are often fairly small (this is taken to the extreme in high frequency trading with many trades each yielding small returns), and;

B) funds typically adopt a small number of strategies (e.g., 1)

Consequently it's more difficult for large funds to find consistently good investments and thus there's a proliferation of small(er) funds.

(Alternatively, if you believe in the Efficient Market Hypothesis much of individual funds positive or negative returns are dumb luck. It's then simply a matter of the fact that the probability of a fund having consistently positive returns -- and consequently having $125bn AUM like Bridgewater -- are exceedingly rare.)

(Edit: extra text deleted)

Perhaps I am daft. In your example, I can't figure out where the 200k is coming from.

I read 100MM in assets, therefore 2MM in fees to manage. 10MM in profits, 2MM to the managers' pockets (which is 20% of these profits). Total to the managers: 4MM, or 40% of the profits.

You are right. It was my mistake, I fixed it. That's what I get when I try to write a comment while trying to juggle some code on the side.

And now that I think about it more, if you consider that hedge fund can lose the money (and still charging 2% management fee), there could be a situation where the managers get the lion's share of profits.

Even then, 379 billion dollars in fees seems really high.

I'm not trying to refute your maths but you might find this book very interesting:

http://www.amazon.com/Zeroes-Misadventures-Decade-Street-Ins...

It's written by the guy who co-founded a magazine publishing company catering specifically to traders, then hedge fund managers and dealmakers.

Inside is a lot of discussion about the top hedge fund people and how much money they were taking home (and spending) at the peak of the boom years. It makes for sobering reading even if you're of a 'well, it's a free country' bent like myself.

> I'm not trying to refute your maths

this is hallucinatory deference to a notion that shouldn't have started to exist in the first place. It's a thinko. Like a typo, only worse. Are you refuting his axioms? Communitivity? No, you're arguing with not even his arithmetic, you're arguing with the choices of inputs to an accepted logic. In no sense of the general concept, are you arguing with his mathematics.

This maths thing is a British thinko from the early 20th century that needs to go. http://oxforddictionaries.com/definition/maths?q=maths

/soapbox

Actually, the numbers do add up nicely. The hedge fund industry (notoriously hard to define, alas) is close to $2 trillion in size and has been that way for several years, give or take a few hundred billion.

http://en.wikipedia.org/wiki/Hedge_fund 3rd paragraph.

>If 30 billion is 2% of the assets, it means that they were managing 1500 billion dollars. The biggest hedge fund in the world, Bridgewater Associates, manages 125 billion dollars.

Uh? I'm not sure what you're talking about here. Man Investments had close to 100 billion under management at their peak and they're a public hedge (very rare). I thought Blackrock was the biggest. They have over 3 trillion under management, though that's everything. 1500 seems small to me given you only need 15 hedges with 100 billion to reach that number.

And if hedge fund generates only 2% profit, investor ends up paying 100% of the profits.