Hedge Funds like Mutual Funds are pooled investments in bonds, equities and other securities and are often distributed by large mutual companies. However, Hedge Funds are far more complex because of the range of investments and positions that can be taken. We will introduce you to the Hedge Fund structure so that you can better understand what to expect.
Component 1: The first component of a Hedge Fund is to understand who shoulders responsibility for fund operations. Responsibility for the funds is shouldered by the general partner, while limited partners are only liable for the money they put into the funds.
Component 2: The next step is to understand how the partnership is structured. As mentioned above the General Partner is responsible includes hiring and managing competent fund managers, marketing and preforming/delegating any other task that is necessary to run a successful business. This partnership is a Limited Liability Company, which is similar to a corporation except that the company must dissolve upon death or bankruptcy of a member. In addition a limited liability company is a “flow through taxation”, meaning that income generated by the entity is considered as income of the investors and owners.
Fees: With Hedge Funds comes both management and incentive fees, these fees are to encourage high performance of managers to make sure that overall profits stay high. Generally management fees hover around 2% of managed assets, this fee can be higher depending on the experience and the track record of the manager; however the incentive fee is what really motivates a manager. An incentive fee is simply intended to reward high returns and this usually ranges from 10-20% based on profits. For instance, if a manager succeeds in brining 30% return over the year, the manager might collect 3-6% of that profit, thus leaving the investor with the remainder, both the investor and manager come away happy. However, to ensure that the manager continues to reach greater heights, he/she only receives this fee when profits exceed the previous high.
Terms and Conditions: Terms and Conditions can differ from hedge fund to hedge fund with several factors to take into account. Depending on the strategy designed by the manager and the liquidity of the underlying investment, subscriptions and redemption can take place monthly or quarterly. This can range from 15 days to 180 days, but it is important for each investor to check if the time ranges are constant with strategy and liquidity.