How Hedge Funds Make Money | The Most Lucrative Business Model

All right, people, welcome back to the channel. Today we're gonna talk about how much money do hedge fund managers actually make, and number 2, how do they make so much freaking money? So welcome back to the channel. My name is Bridger Pennington. I actually run a hedge fund right now. We're way smaller than people I'm about to talk about. We manage about $10 million in our hedge fund, trying to go to $100 million over the next 12 months. But let me just show you a quick list of the top earning fund managers last year. Now, to clarify, this isn't their net worth going up and down. This is income from one Source their hedge fund. You have Jim Simons at the top of the list, $3.4 billion Jim Simons made from one income source. Number 2, Izzy Englander with Millennium Management, $3.1 billion. Next up, you have Ken Griffin with Citadel, $2.5 billion. And down the list, you have a whole slew of fund managers making billions of dollars a year from running a hedge fund. And if you look at the Forbes 100 list, it is riddled With people who run and manage investment funds. That's why running a fund, I keep saying this, is one of the most lucrative things on planet Earth. You need to understand how this game is played. This is the world of hedge funds, private equity, venture capital, real estate funds, debt funds. Okay? They all are put in there. And that's why we started a company called Fund Launch to help people do this. We have over 20,000 people. We've helped multiple funds get over $10 million, 2 funds over $100 million, and 1 fund over $1 billion with Fund Launch. So this is what we do. I eat, sleep, and drink this on this channel. So I wanted to walk you guys through how fund managers, number one, how much they make, and number two, how they make it. So with that, let's go down to the whiteboard of truth and justice. Now, number one, what is a hedge fund? Or even a better question, what is a fund in general? So all a fund is, is a pool of money. Investors put money into that pool. People like me and you that are managers of the money, we go draw from that pool. We can go make investments. When those investments make money, they come back to the pool and they get split between the investors and the managers. That's it. Okay, that's all this whole world of funds is. So, Bridger, what's the difference between all these private equity hedge funds, venture capital, real estate funds, debt funds? What's the difference? How do they work? So, it's funny enough, I work with all these different types of funds. What's crazy enough is they're all almost the same. They're all structured pretty similarly. The only difference is what they invest into. So, for example, we mentioned hedge funds earlier. A hedge fund is a pool of money. They have investments into the public Market. Stocks, bonds, commodities, forex, crypto. That would be a hedge fund. A private equity fund, they are the same thing, a pool of capital. But instead of buying public securities, they buy in the name private securities. They're buying privately held companies. One of the largest private equity firms in the world is Sycamore Partners on Wall Street. They own Kohl's, Nine West Shoes, Aeropostale, Staples, the department store Staples. They are all owned by the same company. We have people in our group doing small private equity. They buy up local car washes, local restaurants. They buy up their neighboring competitors. Okay? That would be private Down here, venture capital. You may have seen the TV show Shark Tank. Again, pool of capital. They invest into small startups. That would be venture capital. Real estate funds. It's in the name. Okay? They have a pool of money and they go buy and sell real estate. Again, they're all structured almost the same way, which is kind of cool. Now to go another layer deeper at how they're structured typically, this is how 99% of funds are structured. So instead of calling them a pool or a manager, they're actually— the pool of capital is called a limited partnership. And it is managed by a separate entity called the general partner. That's you. That's the management team. Okay. So you as the fund manager manage— the general partner manages the limited partnership. So investors or limited partners over here, they have money and they invest into— I'm going to say LPs for short. They invest into your limited partnership or fund. They sign 2 governing documents of the fund, the LPA and the PPM. These are your 2 main documents of a fund that stands for Limited Partnership Agreement and Private Placement Memorandum. And they fill out their Subscription documents, they subscribe to the fund, and now they're fully in and their money's committed, but they have no say over what happens in the fund. That's done by the general partner. You as the general partner get to decide where those investments are made. As long as you stay within the parameter set of LPA, you can't say, hey, we're going to buy real estate, and then all of a sudden say, you know what, we're going to invest into Apple Computer. That'd be different. You got to follow what you say you're going to do, your thesis. Once you do that, those investments make money, the investments flow back to limited partnership, Whatever you make that year, and then they get split between the limited partners and the general partner. You as the fund manager. This is how all these different types of funds run. Now, in just a second, I want to walk you guys through what does this split look like? How much is it? What do you take and what kind of numbers can you produce from running a billion or hundred billion dollar fund like some of these managers are doing? Now, more specifically for hedge funds, a lot of hedge funds will use this model. They also will use what's called a prime broker. This prime broker. Works with the fund to execute their trades. So if they want to go buy a million shares of XYZ company, they usually do that through a prime broker that can be Goldman Sachs, Deutsche Bank, whoever it is. They hold the licenses for you. They hold the Series 7 and the broker-dealer and all that kind of stuff. They help you issue your trades and investments. And then when those trades make money, they flow back to limited partnership. Additionally, some hedge funds also have what's called a management company. This would act as your investment advisor or registered investment advisor, and you would need a Series 65 to launch one of these companies. Again, this is for some hedge funds. It goes by state by state, depends on your legal team. We help you guys figure that out when you guys are in Fund Launch as well. But you potentially would own both of these entities right here. You can also do a hedge fund incubator. Anyways, we got other videos in this channel that talk through all this, what we do. But I want to get to the next section of how do you make money? How do hedge fund managers make money? What's the splits look like? And how is it all broken up? Okay. So I want to give you multiple examples of how this works. Let's say for all these examples below, we manage $100 million in our hedge fund. For the first example, the most common example in hedge funds is what they call the 2 and 20 model. What this means is a 2% management fee and then 20% of the profits. So for example, if this is our hedge fund here, this is 0, 10%, 20%. Let's say our fund did well this year and we got a 25% return overall in the fund on $100 million. Meaning we took $100 million and we turned it into $125 million. So meaning we have $25 million to split up between ourselves and our investors. So how is this split up? 2% is taken to manage the whole fund. So we have a $100 million fund, assuming no leverage is 100%, $100 million capital raised. Us as the general partner, We take $2 million, which now puts our $25 million down to $23 million. We're now going to split that 80/20. So 80% to the investor, 20% to us. So if you total that up, that means our limited partners got $18.4 million and we received $2 million plus $4.6 million for a total of $6.6 million. Not too shabby for running a $100 million fund your first year and getting a 25% return. Now, do remember, in hedge funds, this oftentimes can compound into year 2. Depending on how your hedge fund runs, most oftentimes this money gets deployed back in for year 2 into $100 million. So now you have $118 million. If you keep doing that enough years, it compounds very, very well. And if you treat your investors right and you run an open-end fund, more capital can flow in. Additionally, the other cool thing about hedge funds is you can just add zeros to what you're doing. So instead of managing a $100 million hedge fund, you could manage a billion-dollar hedge fund. And instead of making $6.6 million, you would've made $60 $6 million. Or if you ran a $10 billion hedge fund, you would have made $660 million making the exact same trades with just more capital. $660 million ain't too shabby for one year of work. But I digress. Let's get to the next example. Okay. So let's say same example, you're on a $100 million hedge fund, but this time we're going to do a 2 and 20 model, but we're going to add what we call a pref or preferential rate of return at 8%. We're still going to run the 2 and 20. But what this means is that we as the managers, we don't make any money until the investor at least makes 8% first. Once the investor makes 8%, then and only then we can start profit sharing with the investor. What this does is it makes you get over a hurdle rate of making at least 8% to the investor before us as managers can make any money. So for example, if this year we only made 7% on our fund, we would still collect our 2% management fee of $2 million. But the rest of the 7%, 100% of would go to the investors. We would not take our 80/20 split. Now, some funds will also do what they call a catch-up right here, meaning once we get over 8%, the full 9th and 10th percentiles, these percentiles right here, come to the manager of the fund. Meaning by the time we hit 10%, we are now back to an 80/20 split. So in this event that we got a 25% return, the math would be the same. It would be first 8% would be the investor, the next 2% would come to the managers, and then we'd split from here. 10% on to 25 would be split 80/20. And in that scenario, it actually would result in the same numbers above. If you didn't catch that, you can go back and rewatch that little section. Now, I want to give you a different example of how you can play with these numbers. Now, you don't have to do a 2 and 20. I've seen some funds do a 3 and 30. I've seen some funds do like Jim Simons. He does a 5 and 45, and he's one of the most successful hedge fund managers of all time. They manage, I think, over $100 billion, again, charging 5% management fee and 45% of carried interest. Now, I want to share with you what I do actually in my fund right now. So that's what we do. Let's use the same example of $100 million. We run a 2 and 20, just like before, like I explained. So 2% management fee, 20% carry until we hit 100% APY in one year. So if in the event that we reach 100%, if we double your money in a year, any money over that doubling goes into 50/50. So again, to clarify, from 0 to 100 is 80/20. 80% the investor, 20% to us. Once we hit 100, if we hit 100, we then start going 50/50 with investors. It gives us an incentive to go higher and shoot for the moon. Now, would I recommend this for your fund? I don't know. We did this. We liked it at the beginning. We've liked it so far. I believe for our next fund, I don't think we'll do it. I think we'll come back to just a true 2 and 20 split. And the reason for that is investors are just used to this. They just like that model. You're incentivized to just get bigger gains because you always get 20%. But again, I want to give you the example to show that you can have different hurdles. You could say, hey, if we get at least 30%, we then take a little bit more. I've seen some funds, not in hedge funds, but in a debt fund, they said, hey, investors, once you return a 25% return for the year, we take the rest. I've seen some funds do that. They cap it. And they said, we take a 0% management fee. You make all the money. Every dollar goes to you. The first 25% goes to you in a year. After that, we get the rest. And at the end of the year, we just reset. We go back to zero and we restart. I've seen a lot of funds do that as well, which is pretty interesting. But again, you can go back and do the math. Instead of 100 million fund, if you had a $100 billion fund like some of these fund managers do, Ray Dalio, Warren Buffett, all that kind of stuff, instead of making $6.6 million a year, they're making $6.6 billion a year in their hedge funds. And the coolest thing about hedge funds is many of them don't take very many employees. A lot of hedge funds are ran by maybe 12 to 30 people. That's it. You're splitting up $6.6 billion between 12 to 30 people. That's pretty good returns. And the overhead isn't very high. You're just making clicks on a computer. There isn't this crazy, crazy overhead. Now, if you want to learn more about funds, you guys can click the link below. We have a whole free course on investment funds, private equity, hedge funds, venture capital, how to build them. We go way more in depth on how they're put together, the metrics, how to file with the SEC, the legal documents, all that kind of structure. So click that link below. If you want to work with our team as well, you can give us a call. We have a high top-tier coaching group. We coach people one-on-one through their entire fund setup. You can check out other videos on our channel as well. You guys are amazing. My name is Bridger Pennington. We'll see you next video. Bye.