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16 yrs in alternative finance, Fidelity short-seller, HF analyst, Algo trader

Im always impressed by public answers to this kind of questions because most people here have no idea what hedge fund business really is, except reading some research report by popular economists/journalists or news about hedge fund billionaire in 30s.

My working experience includes some largest hedge funds (arguably best performing ones) so I want to share my opinions.

What is hedge fund?Hedge fund is one kind of investment vehicle that you can park your hard cash and earntheoretical absolute, uncorrelatedreturn. To get that return, you need to pay 2% annual management fee on entire investment and 20% incentive fee on the profit part. This is called 2/20 rule, which is pretty obsolete now due to intensive competition.

Who can invest in hedge fund?Not average Joe. Only accredit investors can. Accredit investors are those who earn an individual income of more than $200,000 per year, or a joint income of $300,000, or have a net worth exceeding $1 million.

Do people in hedge fund get ridiculously rich?Yes and no. Top portfolio managers at top hedge funds can easily get 7-8 digits total comp in good year but most other employees could get anywhere between 100K and 1-2M a year.

Are people get rich off hedge funds only those managers of hedge funds?I hear this claim many many times. But it is false in a very obvious way. If this claim is true, why do those accredit investors still invest in hedge fund after these many years? Most hedge funds are not like Madoff and their client base are mostly institutional investors like sovereign fund, pension fund and school endowment, or extremely high net worth individual.Do you really expect people with that much money are less clever than you and me?

Yes, hedge fund industry as total, the cumulative return last 5-10 years is worse than SP500 ETFor other US index funds. So why do those extremely rich (assuming smart as well) put trillion of dollars to hedge funds? The key is to understand the key wordsabsolute, uncorrelatedreturn.

Hedge fund in general seeks absolute return. This meanthey dont suppose to be compared to any benchmark indices. Some funds are high risk taking and aiming to reach as high return as possible. Some others are low risk taking and aim to get 10% stable return over year. As long as they dont correlate with market much and have high single + return, they are doing fine.

Why do investors want absolute/uncorrelated return?Because most institutional/high net worth investors want diversification. They may already hold a portfolio with 60-80% normal equity/bond investments and want to introduce some alternative, absolute return investments to reduce the overall risk and boost return. I dont want to go too far into portfolio theory here. You can read more here: @Modern portfolio theory

Still, as I mentioned before,the absolute/uncorrelated return is just theoretical, especially in a market that many hedge funds are doing similar things. So dont expect to walk in to any hedge funds and get that. Just like invest in any asset classes (equity, bond, fx etc), you need to do your research.Actually choosing a good hedge fund to invest is not easier than choosing a good stock or bond. Therefore it really doesnt make sense to make any conclusion based on aggregate number of hedge fund industry. Just like you cant say bond is useless because as an asset class it has lower return than equity in general.

Do hedge fund managers get rich win or lose?absolutely not. Yes, they do still make money in some negative year due to management fee. But that usually barely covers operation/human capital cost. The 20% incentive fee is the source to fat bonus and that only happens when investors make money. There is a rule called high water marks to protect investor. It means after hedge funds lose investors money,they can only start to earn incentive fee after they recover the lost first(to the highest water mark). For example, if a hedge fund loses 20% in first year and earns 25% the second year, it just reaches previous high watermark and cant get any incentive fee.

Finally, people who say hedge fund manager get rich win or lose ignore a basic fact:track record matters a lot. In order to become someone who has enough asset under management to earn big pay check, hedge fund manager needs to work his ass off to get many years proved profit for investors. Even after attracting enough capital, hedge fund manager may lose all after a couple of years lose.Who would trust you ever again if you have a bad track record? In this sense, hedge fund managers can only get rich by winning. Not only win once, but many years in entire career.

Oh, one last thing: many hedge fund managers at billionaire level dont get paid that much from client. They earn billions because they put their own money in their funds. Some very successful funds like SAC or Soros are now family office, which only manage their own money.24.3k viewsView 105 UpvotersView SharersThank you for your feedback!Your feedback is private.Is this answer still relevant and up to date?

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