Brief Summary
This video explains hedge funds, highlighting their differences from mutual funds. Key distinctions include less regulation by the SEC, restrictions on marketing and public investment, and a unique incentive structure for managers. Hedge fund managers typically earn a percentage of the fund's profits, aligning their interests more closely with fund performance compared to mutual fund managers who primarily earn a percentage of assets under management.
- Hedge funds are less regulated than mutual funds, restricting their marketing and access to public investment.
- Hedge fund managers are incentivised through a percentage of the profits, aligning their interests with fund performance.
- Investing in hedge funds generally requires being an accredited investor due to the higher risk and lack of regulation.
Understanding Hedge Funds
Hedge funds are often viewed with suspicion due to their secretive nature and sometimes questionable activities in the market. Unlike mutual funds, hedge funds are not regulated by the SEC, which means they cannot market themselves to the general public. This is why you won't see advertisements for hedge funds in financial media. The largest hedge funds are not household names because of these marketing restrictions.
Regulation and Investor Requirements
Due to the lack of regulation, hedge funds cannot accept money from the general public. To invest in a hedge fund, one must be an accredited investor, meaning they possess a certain net worth, income, or level of financial sophistication. This requirement ensures that investors are capable of understanding the risks associated with unregulated investments, reducing the need for SEC oversight to protect them.
Incentives for Managers
The incentive structure for hedge fund managers differs significantly from that of mutual fund managers. Mutual fund managers typically receive a percentage of the total assets under management, incentivising them to increase the fund's size through marketing efforts. They don't directly benefit from the fund's profits, reducing their motivation to aggressively outperform the market. In contrast, hedge fund managers receive larger management fees, typically between 1% to 2% of assets, and also get a percentage of the fund's profits.
Profit Sharing in Hedge Funds
Hedge fund management companies, or general partners, commonly receive around 20% of the fund's profits. This percentage can vary, with some highly successful hedge funds earning 25%, 30%, or even more. This profit-sharing arrangement strongly aligns the interests of the hedge fund managers with the fund's performance, motivating them to generate higher returns. The next video will illustrate the mechanics of returns for both hedge funds and traditional mutual funds.
