Investments, tenth edition

  Liquidity   

Hedge funds often impose    lock-up  periods,      that is, periods as long as several 

years in which investments cannot be withdrawn. Many also employ redemption notices 

that require investors to provide notice weeks or months in advance of their desire to 

redeem funds. These restrictions limit the liquidity of investors but in turn enable the funds 

to invest in illiquid assets where returns may be higher, without worrying about meeting 

unanticipated demands for redemptions.  

  Compensation Structure   

Hedge funds also differ from mutual funds in their fee struc-

ture. Whereas mutual funds assess management fees equal to a fixed percentage of assets, 

for example, between .5% and 1.5% annually for typical equity funds, hedge funds charge 

a management fee, usually between 1% and 2% of assets,  plus  a substantial  incentive fee  

     26.1 

Hedge Funds versus Mutual Funds  

  

1

 These are funds that may sell short up to 30% of the value of their portfolios, using the proceeds of the sale to 

increase their positions in invested assets. So for every $100 in net assets, the fund could sell short $30, investing 

the proceeds to increase its long positions to $130. This gives rise to the 130/30 moniker. 

bod61671_ch26_926-950.indd   927

bod61671_ch26_926-950.indd   927

7/25/13   2:04 AM

7/25/13   2:04 AM

Final PDF to printer

---

928

P A R T   V I I

  Applied Portfolio Management

equal to a fraction of any investment profits beyond some benchmark. The incentive fee 

is often 20%. The threshold return to earn the incentive fee is often a money market rate 

such as LIBOR. Indeed, some observers only half-jokingly characterize hedge funds as “a 

compensation scheme masquerading as an asset class.”