Hedge funds intro | Finance & Capital Markets | Khan Academy

0:00 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.

0:47 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

1:33 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.

2:20 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.

3:11 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.