Hedge funds intro | Finance & Capital Markets | Khan Academy

In this video I want to
see if we can understand the idea of a hedge fund
a little bit better. And these tend to be
pretty mysterious, and sometimes get a bad name
because some hedge funds do do some fairly strange
things and secretive things in the market. So people are, rightfully so,
suspicious of many of them. But the real difference between
a hedge fund and the types of mutual funds that
we just talked about are that they're not
regulated by the SEC. And because they
are not regulated they can't market themselves. That's why when you
watch financial shows, or you get a magazine,
a finance magazine you will not see
ads for hedge funds. The mutual funds are
all over the place, marketing them left and right. Hedge funds the largest
hedge funds in the world are definitely not
even household names. Very few people even know
what those largest hedge funds in the world are. And that's because they
can't market themselves.

No matter how good
of a track record, or really how
reasonable of a fund they might be– some might
not be reasonable, some are– they can't market themselves. And they also can't take
money from the public. So in general, in order
to invest in a hedge fund, you have to be an
accredited investor, which means you have a
certain net worth, or maybe you have
a certain income, or maybe by virtue
of your education you can prove that you have a
certain level of sophistication to invest in these things
that aren't regulated. You, I guess, don't need
the SEC to watch your back. So the regulation
is a key difference. Marketing, no money
from the public. And then the other
key difference is how the managers
tend to be incented. I know incented is not
a word, or motivated. In the mutual fund
world, managers get a percent of assets.

So for mutual fund
manager, larger is better. The more under
management the more money the mutual fund
manager's going to make. So they really just want to
keep marketing it, marketing it, marketing it. They don't get a
cut of the profits. So you really there's not a lot
of incentive to kind of really beat the market here.

Because if they kind of don't
be the market one year, then all of a sudden, their
fund will shrink. So they really just get a
fee on the size of the fund. In a hedge fund, and
usually the implication is that a hedge fund will
be more actively managed, they'll get a larger
management fees. So larger management fee,
instead of the 1%, 1% is actually a lot
for mutual fund. Instead of that, hedge
funds tend to be 1% to 2%. So 1% to 2% management fee,
and sometimes even larger than that. But the even I guess
bigger difference, and this is where
hedge funds are very different from a
traditional mutual fund, is that the management
company, the general partner, gets a percentage
of the profits.

So with a hedge fund manager
or the management company, the going rate tends to be about
20$ of the profits of the fund. Sometimes it's less,
sometimes it's a lot more. Some very successful hedge
funds get 25%, 30% or even a larger percentage
of the profits. So with that out of the
way in the next video, I'm going to do some different
mechanics of essentially the same returns,
but one by hedge fund and then one by a
traditional mutual fund.

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