How hedge funds charge, and whether they are worth it
The fee is certain. The alpha is not. That asymmetry is the entire debate.
Understand what a performance fee actually costs, and what it must beat.
How hedge funds charge works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
What a 2% fee costs over thirty years
Both lines earn the same 8%. One pays 0.07% a year, the other pays 2%. The gap is not a rounding error, it is most of the point of the exercise.
- 1
The structure
Two percent of assets annually, whether the fund makes money or loses it, plus twenty percent of any profits. The management fee alone, on a large fund, is a fortune before a single good decision has been made.
- 2
The bar it must clear is higher than it looks
To beat a cheap index fund charging 0.07%, the manager must not merely beat the market. They must beat it by roughly two percent plus a fifth of everything they earn above that, every year, forever, net of trading costs.
- 3
And most of the reported outperformance is not alpha
Much of what is presented as skill turns out on inspection to be hidden leverage, illiquidity, or a strategy that quietly sells insurance against rare disasters. That produces small steady profits and looks wonderful right up until the disaster arrives.
A high Sharpe ratio from a strategy with rare catastrophic losses is not evidence of skill. It is evidence that the catastrophe has not happened yet.
- 4
Some genuinely earn it
A small number of managers have produced real, persistent alpha over decades. They are famous precisely because they are rare, and most of them are closed to new money, which tells you something about how scalable the skill is.
You can calculate what two and twenty costs over twenty years, and compare it against a tracker.
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The fee is certain. The alpha is not. That asymmetry is the entire debate.
Every one shows its exact method, and the circumstances in which it is wrong. Free, and no account to look.