Hedge Fund Fees Explained: 2 and 20, High-Water Marks and Hurdle Rates

Hedge fund fees usually have two parts: a management fee charged on the assets invested, and a performance fee charged on the profits the fund earns. The traditional model is known as "2 and 20" — a 2% management fee and a 20% performance fee — but in practice the level, the calculation and the investor protections built around these fees vary considerably. This guide explains how hedge fund fees work, what high-water marks and hurdle rates do, and how fees affect the return an investor actually keeps.

How Do Hedge Fund Fees Work?

A hedge fund charges a management fee to cover the cost of running the fund and a performance fee to reward the manager for generating profits. According to the SEC's investor education site Investor.gov, investors typically pay an asset management fee of 1–2% of net asset value and a performance fee of 15–20% of the fund's profit, subject to measures such as a high-water mark and a hurdle rate.

The combination is what distinguishes hedge funds from most traditional funds, which usually charge only an annual management fee. The broader business model behind this fee structure is described in our article on how hedge funds make money, and the differences to mutual funds and other vehicles are set out in hedge funds vs mutual funds, private equity and investment banks.

What Does "2 and 20" Mean?

"2 and 20" is shorthand for a 2% annual management fee plus a 20% performance fee on profits. It became the reference point for the hedge fund industry and is still the benchmark against which other fee arrangements are compared, even though many funds today charge less on one or both components.

The management fee

The management fee is calculated as a percentage of the assets the investor has in the fund, usually accrued over the year and paid monthly or quarterly. It is charged whether the fund makes money or not, and it pays for research, trading infrastructure, risk management, compliance, administration and staff.

The performance fee

The performance fee — also called an incentive fee — is a share of the profits the fund generates over a defined period. Its purpose is to align the manager's interests with those of investors: the manager earns more only when investors earn more. The SEC's investor bulletin on hedge funds also points out the flip side — a performance fee could motivate a manager to take greater risks in the hope of a larger return — which is why the mechanisms below matter.

A Simple Example: How Fees Affect Your Return

Fees can take a substantial share of a fund's gross return, so it is worth working through the numbers. The following example is purely illustrative and simplified; actual calculations depend on each fund's documents.

An investor holds 1,000,000 in a fund for one year.
The fund earns a gross return of 10%, or 100,000.
A 2% management fee costs 20,000, leaving a profit of 80,000.
A 20% performance fee on that 80,000 costs 16,000.
The investor keeps 64,000 — a net return of 6.4% on a gross return of 10%.

In this example fees absorb more than a third of the gross return. That is why performance comparisons should always be made net of fees, a point we also make in our analysis of how many hedge funds beat the market.

What Is a High-Water Mark?

A high-water mark is the highest net asset value on which the manager has previously been paid a performance fee; the fund must climb back above that level before a new performance fee can be charged. It prevents investors from paying twice for the same gains.

For example, if a fund's value per share rises from 100 to 120, the manager earns a performance fee on the gain of 20 and 120 becomes the high-water mark. If the value then falls to 100 and later recovers to 115, no performance fee is due, because the fund has only recovered part of its previous loss. A fee becomes payable again only on gains above 120.

In the EU, the ESMA guidelines on performance fees (ESMA34-39-992) apply to UCITS and certain alternative investment funds marketed to retail investors. Among other things, they require that past losses be recovered before a new performance fee is paid and that performance fees generally crystallise no more than once a year.

What Is a Hurdle Rate?

A hurdle rate is a minimum return the fund must achieve before any performance fee is charged. It ensures that the manager is rewarded only for returns above a defined threshold — for example a fixed percentage or a money market rate — rather than for returns an investor could have earned with little risk.

Hurdles come in two main forms:

Hard hurdle — the performance fee is charged only on the return above the hurdle.
Soft hurdle — once the hurdle is exceeded, the performance fee is charged on the entire return, including the part below the hurdle.

A high-water mark and a hurdle rate are often combined: the fund must both recover past losses and exceed the hurdle before a performance fee is earned.

Other Fee Terms Investors Should Understand

Beyond the headline percentages, several technical terms determine what an investor actually pays:

Crystallisation — the point at which an accrued performance fee becomes payable to the manager, typically annually. More frequent crystallisation can increase the total fees paid in volatile years.
Equalisation or series accounting — methods that ensure investors who enter at different times each pay a performance fee only on their own gains.
Pass-through expenses — some funds, particularly large multi-strategy platforms, charge certain costs such as trader compensation directly to the fund instead of a fixed management fee. How these platforms work is explained in our article on multi-strategy hedge funds.
Fund and operating expenses — administration, audit, custody and legal costs, which may be borne by the fund in addition to the management fee.
Liquidity terms — lock-ups and redemption notice periods are not fees, but they are part of the same negotiation and affect the overall value of the arrangement.

Fees in a Fund of Hedge Funds

A fund of hedge funds charges its own management fee, and sometimes a performance fee, on top of the fees of the underlying hedge funds. This second layer pays for manager research, due diligence, portfolio construction and ongoing monitoring across several managers. Whether it is worth paying depends on the value the allocator adds through access, diversification and risk control — the trade-offs are discussed in our article on multi-manager hedge funds.

AQUIS Capital, a Zurich-based asset management boutique licensed by the Swiss Financial Market Supervisory Authority (FINMA), manages the AltAlpha SICAV – Abacorum Fund, a fund of hedge funds investing across long/short equity, long/short credit, global macro and event-driven strategies. The applicable fees and terms for any fund are set out in its official offering documents.

How to Compare Hedge Fund Fees

Comparing hedge fund fees means looking beyond the headline "2 and 20" to the terms that determine the real cost. Useful questions include:

Is there a high-water mark, and is it ever reset?
Is there a hurdle rate, and is it hard or soft?
How often does the performance fee crystallise?
Which expenses are charged to the fund in addition to the management fee?
Are lower fees available for larger commitments or longer lock-ups?
What has the fund returned net of all fees, and how consistent were those returns?

Fees are only one part of the picture: a more expensive manager can still be the better choice if the net result is consistently stronger. Our guides on hedge fund manager selection and how to invest in hedge funds cover the wider due diligence process.

Frequently Asked Questions About Hedge Fund Fees

What are typical hedge fund fees?

Hedge funds typically charge a management fee of 1–2% of net asset value and a performance fee of 15–20% of profits. The traditional benchmark is "2 and 20", but actual terms vary by fund, strategy and investor size.

What does 2 and 20 mean in hedge funds?

"2 and 20" means a 2% annual management fee on assets plus a 20% performance fee on profits. The management fee is charged regardless of performance; the performance fee is charged only on gains, usually subject to a high-water mark.

What is a high-water mark in a hedge fund?

A high-water mark is the highest value on which a performance fee has already been paid. The fund must exceed that level again before a new performance fee is charged, so investors do not pay twice for recovering the same losses.

What is the difference between a hurdle rate and a high-water mark?

A high-water mark protects investors from paying fees on the recovery of past losses, while a hurdle rate requires the fund to earn a minimum return before a performance fee applies. Many funds use both mechanisms together.

Are hedge fund fees worth it?

Hedge fund fees are worth paying only if the fund delivers returns, diversification or risk reduction that investors could not obtain more cheaply elsewhere. The decisive figure is the return after all fees, assessed over a full market cycle.

Read more about AQUIS Capital and the team behind it, explore the AQUIS Capital fund range, or contact the team with your questions.

This content is for general information only and is not financial, investment, tax or legal advice. Investments carry risk, including the possible loss of capital. Consult a licensed professional before making decisions.