I have long wondered how a hedge fund actually works. Not enough to look it up or do any research or ask anyone, but enough that I’ve on occasion thought to myself:
What’s a hedge fund?
Well, through my reader today came Jonathan Field’s pretty good, down and dirty description of a hedge fund.
I feel much smarter now.
Well, not much, but a little bit.
For those not in the know, here’s how “the money” in hedge funds work…
Hedge fund managers put in 0.25% of the money in a fund (sometimes more), then get other people to entrust them with the other 99.75% to invest on their behalves. So, if you raise a $100 million fund, you might put in $250,000, and take in another $99,750,000 from other investors.
Now, as the managers, you take a yearly management fee, anywhere from 1 to 5%, so that’s $1-$5 million a year, regardless of how the fund does. Then, you take 20% of the gains on the entire amount, that’s called the “carry.”
So, if you manage $100 million, the fund generates an average 20% return/year (which is the expectation in many funds) and the fund is in place for 10 years, before it’s fully liquidated, the net gain is $200 million. You get 20% of the $200 million gain or $40 million.
If the fund was a $1 billion (many are), you’d get $10-$50 million management fee and $400 million.
Is the carry guaranteed? Of course not, but, you can see pretty quickly why, for so many people, becoming a hedge fund manager has been the holy grail of Wall Street jobs (barring the last few months).
