6 Things You Didn’t Know About Hedge Funds

3. This doesn’t mean that hedge fund managers are complete idiots when it comes to picking stocks. Remember, they charge close to 2% in management fees and close to 20% in performance fees. So, if their raw return due to beta exposure is 15%, their investors will have to pay 2 percentage points in management fees and 3 percentage points in performance fees. If they are able to generate 3% in alpha (extra return), again 0.6 percentage points will be deducted as performance fees. Overall, the fund investors will realize about 12.5% in net returns or about 2.5 percentage points below what they would have achieved on their own in index funds. In this example, the hedge fund manager was able to generate an alpha of 3 percentage points but this wasn’t enough to justify his fees of about 5.5 percentage points. In other words, hedge fund managers can still beat the market by picking the right stocks on average, but the margin isn’t big enough to justify their fees. Usually nobody tells you this. Does this mean that you should avoid hedge funds and invest in index funds? Please don’t answer this question yes.