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Current time:0:00Total duration:6:51

Video transcript

let's see if we can understand the structure of a hedge fund a little bit and also how the management and the performance fees work out so most hedge funds the funds themselves are set up as limited partnerships so this is the hedge fund that Pete set up we'll call it Pete capital fund one he's maybe in the future going to start fund two and fund three and all of the rest and he's able to raise a hundred million dollars ten percent of that hundred million dollars or ten million of it is coming from him we're I guess to be more exact it's coming from Pete Capital Management LLC limited liability company which he starts off as the general partner of this fund and just it might be a little bit confusing but this is one company this is another company over here this company is going to manage the assets of that company and in return it will be able to get management fees and it will be able to get performance fees and we'll talk about that in a second and probably Pete owns this entire company but he might have a couple of employees probably four or five now the way it works with the limited partnership is they don't call it that necessarily shares but it's essentially the same thing someone who out of this 100 million contributed 30 million would get 30% in limited partner interest someone who contributed 10% would get 10 million in limited partner interest so let's just say that he does really good over the next year that he's able to on a gross basis before we take out his management fee or anything else grow the fund by 20 million dollars so roughly on a gross basis 20% but this is this is net of you know the trading fees and all of the stuff that he has to pay the broker and and all of that type of thing to understand kind of what goes to Pete capital management that Pete can use to pay himself and his handful of employees first he gets the management fee and the management fee will be on the average net asset value and I'm going to do it a little bit back of the envelope right over here it's normally done on a monthly basis but I don't want to go into all of the accounting but if you did this fairly linearly or if he does this fairly consistently the average net asset value over the year would be about a hundred ten million dollars so average would be approximately one hundred and ten million dollars and so he'll get about two percent of that we're assuming he gets a two percent management Phee and 20% performance fee or 20% carried interest it's sometimes called so if the average net asset value is 110 million you multiply that times 2 percent and then that means that he's going to get 2.2 2.2 million dollars in management fee and this is for his salary his employee salary to pay the rent - I know get some fancy computers whatever it might be this is kind of viewed as the cost just to manage the fund so we need to subtract that from the total amount in the fund because that's going to the management company so instead of 120 million over here we're going to have what is that 117 117 million 0.8 117 point 8 million and then we'll have to calculate how much he gets in a performance fee so in this situation net of his management fee we have a seventeen point eight million dollar gain so let me write that over here we have seventeen point eight million in profits the way that we've set up the performance fee or the carried interest is that Pete gets twenty percent of it or more particular the general partner the Pete met Pete Capital Management LLC the partner that is controlling that is managing this fund will get 20 percent so let's multiply that times 20 percent and what does that give us that gives us three point five six million so three point five six million will also will also go to Pete Capital Management's so not bad and this year he made a little almost six million dollars and that's probably going to go to him and you know probably four or five employees so it can if someone performs well it can be a very profitable business and just to make it clear how the mechanics work here is that these these funds tend to be open-end funds like open end mutual funds will not like them they have to be private they can't they can only take money from accredited investors they can't market themselves they don't have to register with the SEC but when I say that they are they can be open-ended it means that at any point well not at any point usually this is restricted at certain points in time the investors are allowed to redeem or kind of add investments to what's going on in the fund so let's say after at the end of the year so instead of 117 point eight we're gonna have to subtract three point five six from that for peat capital management so what's left and the fund is going to be and he could leave it in there to reinvest but that would just increase his share but let's say peat capital management takes it out so we'll be left with let's see we have one hundred seventeen point eight minus minus three point five six right minus three point five six gives us one hundred fourteen point two four so over here what's left on the fund is one hundred fourteen point two four and let's say this period investors are allowed to redeem their interest and let's say this guy right over here this guy with a thirty percent interest he says you know what that's that was a pretty good year I want to take ten percent of my interest out so instead of having a thirty percent interest he wants to have a ten percent interest so what happens is so instead of a thirty percent this is now a twenty percent interest he'll take ten percent out so he'll take ten percent of one hundred fourteen point two four so he's going to take out that's essentially going to be we just have to move the decimal place one over so he's going to take out eleven point four to four million that's this guy right over here he's going to take out eleven point four to four million and then the fund will decrease by that amount so he can add these specific periods people can redeem usually it's at the end of the month at the end of the quarter or the end of the year and so then the fund will be left with what's 140 take the calculator out again the fund will now be left with one hundred fourteen point two four minus eleven point four to four which is going to be 102 point eight one six one hundred two point eight one six and at the same time other people might say hey gee that was a pretty good return I'm going to now contribute to the fund so either way it's not like it's a closed-end fund we're just at the beginning people can commit their capital and they can't take it out until the end of the fund or they can't add more during the life of most hedge funds at specific periods people are allowed to redeem their funds or they're allowed to add more funds