Let us break this down
1. Investors give money to a manager
2. They shake on a deal
3. This gives the manager full autonomy like a king of their money
4. The fund has quant analysis to see trends in the market
5. And they invest your money in high risk high reward situations
Now let us piece this together, you as an investor give money to a manager, and shake on a deal that gives the manager full control of your money, this allows the hedge fund to act like a king without rules or jurisdiction. The fund has quant employee’s who look for trends and potential trades and they invest your money in the market in a high risk, high reward method.
Breaking Down Hedge Funds
$215,000, that is how much the top CEO’s of hedge fund companies make on an hourly basis. Yup, HOURLY... Now some of you have probably heard or watched the show “Billions” on SHOWTIME but are still confused by what Bobby Axelrod does, so lets talk about what Hedge Funds are and let you decide if the pay is justified.
A hedge fund is simply characterized as an investment partnership, where investors provide capital to hedge fund managers, and give them autonomy over their investments. So basically, it is a place where you give money to a manager and give them complete control of your money. To invest in a hedge fund, you must have a have a net worth of $1 million (excluding your home) and earn roughly $300,000 a year. Unlike a mutual fund, hedge funds are unregulated and have little to no oversight by the Securities and Exchange Commission (SEC). They don’t have limitations on investment strategies and there is no adherence to specific reporting requirements aka they are not fiduciary. With that being said, these funds can be risky investments, and follow the classic saying of higher risk, higher return.
Okay now to the fun math party, how they get paid. Hedge Funds go off a performance and fee structure, commonly known as the “Two and Twenty” rule. A 2% assets under management fee (AUM) each year and then a 20% cut of any capital gains generated.
Imagine investing 5 million into a hedge fund; That is $100,000 a year of base income for the hedge fund from asset under management fees AND that is not assuming the $5 million invested is even going to grow! Now, If your $5 million grows to $7 million after one year then the hedge fund will keep 20% of that 2 million, which is……. $400,000 plus a now $140,000 from the 2% fee from assets under management ($7 million). Which makes a grand total of $540,000 in fee’s from just one client!
Compare this to wealth managers that charge anywhere between 0.5%-3% AUM and you can see the difference, yes there is a high risk, high return aspect which means you may make higher returns but you may also lose your shirt!. If you look at 2008 hedge funds lost an accumulated $450 BILLION. With a “B”. 2008 was a year where most financial institutions performed poorly, however the severity of the losses with hedge funds in comparison to; mutual funds, individual stocks, balanced portfolios were by far the worse. When you are an investor and looking where to put you money, it all comes down to what your goals are and how comfortable you are with risk. Yes, Hedge Funds make tons of money for themselves and for you, sometimes more themselves but is it worth the risk? We here at Orca believe that is up to you and believe in not just making money but planning for your secure future as well. Please reach out here if you would like to learn more about the Orca Mantra.
