May 18, 2006
Hedge funds resemble mutual funds?
The total amount estimated to be managed by hedge funds stands at $1 trillion today; or about 7 percent of total U.S. financial net worth. And returns to large hedge funds, those with over $3 billion under management, are averaging between 10 and 15 percent annually. This is a far cry from the 40 and 50 percent that hedge fund managers used to get for their investors a few decades ago. Hedge funds began making money through their aggressive inclination to invest in more rapidly rising foreign stock and bond markets. However, as institutional investment in hedge funds increases, there is now a call for hedge funds to be less risk-taking and provide a more stable rate of return over a long period of time – something like a mutual fund.
Then what pray is the difference between the two types of funds now? Well despite the need to restrain more aggressive activity, hedge funds can still pursue a more unconstrained investment approach than most mutual funds. They can still employ leverage by going short, and pursuing multiple strategies. However, that does not deter from the fact that hedge funds ARE slowly beginning to resemble mutual funds. And the most obvious similarity is the structure.
Hedge funds are increasingly being structured more like mutual funds. Investment strategies that depend on long-only equity have allowed more institutions to expect a fixed rate of return on their investments annually. However, the downside of this effect is that despite hedge funds resembling mutual funds, their fee structure is still on the high side. Most hedge funds employ a two-and-twenty fee structure wherein the hedge fund manager gets 2% of the investments to operate the fund for the first year plus 20 percent of the upside of anything he earns. This fee structure often leaves small investors with returns no greater than, or sometimes less than, returns on mutual funds.
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