Chapter 9
Hedge Funds
Hedge funds are difficult to define if only because they have morphed into so many different shapes. The term hedge used to mean that the funds attempted to hedge one set of assets with another. This was certainly true of the first hedge fund formed in 1949 by A.W. Jones, and is still true of hedge funds following market-neutral strategies (as explained later). But many hedge funds have directional strategies that are anything but hedged.
Perhaps it’s better to define hedge funds by the fees they charge. The Investment Company Act of 1940 insists that a Registered Investment Company (RIC) like a mutual fund charge symmetrical investment fees. So their fees remain fixed in percentage terms whether the fund rises or falls. Hedge fund managers insist on asymmetrical fees typically consisting of a management fee paid regardless of performance and an incentive fee charged as a percentage of the upside. A typical fee schedule would be to charge a 1 percent or 2 percent management fee on all of the assets under management and a 20 percent incentive fee.1 To avoid having to register as an RIC, the hedge fund must be offered to investors only through a private placement.
Hedge funds are organized as partnerships with the general partners being the managers and the limited partners being the investors. The form of the partnership is similar to that used by private equity and venture capital firms. In fact, these firms also charge asymmetrical investment fees. So how ...
