What Is Two and Twenty?

What Is Two and Twenty?

Let me explain what two and twenty means to you as an investor or someone curious about finance. It's a fee setup that's standard in the hedge fund world and pops up in venture capital and private equity too. Hedge fund managers charge you both a management fee and a performance fee. The 'two' is 2% of the assets under management (AUM), which is the yearly fee for handling your money. The 'twenty' is the 20% cut they take from profits the fund makes beyond a set benchmark.

Key Takeaways

To break it down directly: 'two' is the 2% annual management fee on assets, and 'twenty' is the 20% incentive on profits over a hurdle rate. This setup has turned many hedge fund managers into multi-millionaires or billionaires, but investors and politicians are watching it closely. Also, a high watermark might apply, meaning the manager only gets paid on profits if the fund's value tops its old high.

How Two and Twenty Works

Here's how it operates in practice. You pay the 2% management fee no matter what—win or lose. If a manager handles $1 billion in AUM, that's $20 million a year, even if the fund tanks. The 20% performance fee kicks in only if the fund beats a hurdle rate, which could be a fixed percentage or tied to an index like stocks or bonds.

Some funds add a high watermark to this. It means the manager earns on profits only if the fund's net value beats its prior peak. This stops them from cashing in big on mediocre results and forces them to recover losses first.

Two and Twenty: Adding Up to Billions

These fees add up massively. In 2023, the top 10 hedge fund managers pulled in $3.43 billion combined. For instance, Israel Englander from Millennium made $2.8 billion, Ken Griffin from Citadel got $2.6 billion, David Tepper from Appaloosa earned $2.3 billion, Steve Cohen from Point72 took $1.6 billion, and Jim Simons from Renaissance Technologies, who passed away in 2024, made $1.3 billion.

Their huge funds generate millions just from management fees, and years of strong strategies bring in billions more from performance. But the real question for you is whether most managers earn enough returns to warrant this model, even if stars like these do.

Is Two and Twenty Justified?

Take Jim Simons as an example—he founded Renaissance Technologies in 1978 as a quant fund using advanced math models. Their Medallion fund, started in 1988, averages 40% annual returns after fees of 4% management and 44% performance. It's closed to outsiders since 1993 and only for employees now.

Bridgewater Associates is the biggest hedge fund manager as of mid-2024, with $89.6 billion in AUM. Medallion's outsized returns might justify the fees, but that's rare. Most hedge funds lag the market, underperforming the S&P 500 year after year since 2011. Data shows they're not reliable for absolute returns.

Warren Buffett pointed out in 2017 that chasing elite advice has wasted over $100 billion for investors like the wealthy and institutions.

Loss of Favor

Hedge funds were hot once, but now investors are bailing due to weak performance and high fees. In 2023, outflows hit $75 billion; in 2022, it was $112 billion. By late 2023, hedge funds returned 5.7% while the S&P 500 soared 24%. In 2024, hedge funds were at 7.67% by October, against the S&P's 25%.

An Example of Two and Twenty

Let's look at a hypothetical fund, Peak-to-Trough Investments with $1 billion AUM at Year 1 start, closed to new money. It grows to $1.15 billion by end of Year 1, drops to $920 million by Year 2, then climbs to $1.25 billion by Year 3.

In Year 1: Management fee is 2% of $1.15 billion, so $23 million; performance fee is 20% of $150 million growth, $30 million; total $53 million.

Year 2: Management fee 2% of $920 million, $18.4 million; no performance fee since below $1.15 billion high watermark; total $18.4 million.

Year 3: Management fee 2% of $1.25 billion, $25 million; performance fee 20% of $100 million above watermark, $20 million; total $45 million.

What Is the Average Performance Fee for a Hedge Fund?

While 2% and 20% is standard, averages differ. Globally, arbitrage funds average 1.38% management and 19.57% performance; long-biased funds are at 0.85% and 10.49%.

Can I Invest in a Hedge Fund?

You can only if you're accredited by SEC standards: income over $200,000 for two years, net worth over $1 million (excluding home), or holding Series 7, 65, or 82 licenses.

What Do Hedge Funds Do Exactly?

They're like mutual funds or ETFs but for accredited investors—high-net-worth folks or institutions. They pool money to chase alpha, using bold strategies to beat the market. They're riskier, less regulated, and can go long or short.

The Bottom Line

Hedge funds target accredited investors to generate market-beating returns via unique tactics. They charge 2% on AUM and 20% on profits, but data shows they rarely outperform the S&P 500, leading to high fees and outflows.