A hedge fund is a private and unregulated pool of monetary backing that is primarily used to participate in any form of business transaction that is projected to be profitable in the near future, but may pose as a great risk at the present time. It is used to take security against one investment versus another. Taken from the word “hedge,” hedge funds are used as a form of investment to cancel out – or at the very least, reduce the risk of heavy losses in another investment.
Hedging has always been a favored financial strategy, especially among speculative traders in the financial markets of the world. But that does not mean that the more conventional and conservative traders do not engage in such a practice. Hedging is also known as speculation in the basis, where the basis is the difference between the hedge’s theoretical value and its actual value (quoted from Holbrook Working, professor of Economics, Stanford University.)
And because there is a very large population of traders who rely heavily on hedging, hedge funds have been created to fill the need. Hedge funds, therefore, is a legal and recognized financial vehicle for holding and investing money on behalf of its numerous investors. Hedge funds can be used for almost any asset, product, or service. The managers of the said hedge funds can even use the money to place bets as to the appreciation or depreciation of assets on the trading block. Only a very select group of people are invited t join in hedge funds; and it charges for both a management fee and a performance fee.
Management Fee
Management fee is used to hire, educated and maintain the funds’ people – or hedging funds managers, as they are called. Finding and training the right professionals to do the job is essential since the money involved here is quite substantial. Also, the number of investors pooling their financial resources within these hedge funds (at any given time) may not be great in number, but the money they have in it can be staggering. These investors (naturally enough) will not take kindly sudden and massive losses; hedge funds managers are often times given free rein to make sure that the aforementioned losses do not happen too often, if at all.
Management fee ranges between 1% and 4% per annum of the net asset value of the hedging fund. So if the present value of the hedging fund is pegged at $1 billion per annum, management fee totals to an easy $20 million. Managers can opt to have their payments delivered either monthly or weekly.
Performance Fee
Performance fee is like a commission for the positive returns on the part of the manager(s). Unsurprisingly enough, hedge funds manager(s) do not get anything should losses happen. Therefore, the promise of a good performance fee makes sure that the hedge funds manager(s) perform well with profits (and large profits at that) in mind.
Performance fees are never standardized or regulated. It is usually calculated as a small percentage of the hedging funds’ profits – taking into consideration both actual realized trading profits and the unrealized profits. Sometimes too, the amount of the performance fees is dependent on the generosity (or lack of it) from the participating investors who score financial gains over one transaction. As such, a hedging fund manager can easily rake in a few hundred thousand dollars for very successful ventures; that is aside his or her share of the management fees.
