Hedge funds and other alternative investment funds were developed on the basis of exceptions from the securities legislation enacted in the U.S. in the 1940s to regulate collective investment undertakings. The purpose of the exceptions was to exclude “private investment companies” and personal and family holding companies from the scope of legislation. However, the SEC “knowingly permitted any group of up to 100 people to create a private investment pool”.
A hedge fund is usually structured as a limited partnership or limited liability company to give the general partner (the fund manager) a share of the profits earned on the limited partners or members (the investors) money. The profit sharing (referred to as a “performance fee” or an “incentive allocation” if referring to an onshore fund) is typically 20 to 30 percent of the fund’s profits. Management fees are typically 1 to 2 percent of assets under management and are paid to support the cost of day-to-day fund operations.