I believe the 20% cut that the manager make is after they clear a benchmark like the S&P 500 to ensure they get paid when they produce a superior return compared to what an index fund could deliver.
For example, let me pitch you on the Patio11 Hedgehog Fund. It uses complicated financial alchemy to produce market-beating returns, and you only pay if we beat the market. The fund has never lost money. Care to invest $10 million? You pay 2% per year and 20% of returns above the S&P 500.
Hypothetically suppose the S&P is up 10% next year. I deliver 20% returns. Alchemy, what can I say. You make $1.6 million, I make $0.4 million (from you), and since I did this in parallel with 100 other people life is pretty grand for me.
Now just between HN and me, my strategy is simple: I buy the S&P 500 as an index but I use 2X leverage.
What would have happened if the market went down 5% next year? Well, we would have lost 10%. That certainly sucks, and you need to make your $1 million back. Which is great, because I am now accepting new money on the Patio11 Chinchilla Fund. It uses complicated financial alchemy to produce market-beating returns, and you only pay if we beat the market. The fund has never lost money.
Well to be fair, it's also not the real hurdle than any investor in Hedge funds use. It's more of a marketing term than anything else (and often funds don't target the S&P as their benchmark, but something else closer to their trade category).
Almost all investors in hedge funds will want to see the portfolio of all previous funds you've managed as well as how much of your own money you have in the fund, how much leverage you are doing, alpha, beta, risk adjusted metrics etc.
That said, the Hedge Fund industry is going through a consolidation. Lots of small funds were essentially S&P indexes with leverage/hedges and execution ability. The rise of ETFs, the decrease in execution costs, and the creation of a true history of performance has made those funds pretty obviously useless and they are (rightly, I believe) dying.
For example, let me pitch you on the Patio11 Hedgehog Fund. It uses complicated financial alchemy to produce market-beating returns, and you only pay if we beat the market. The fund has never lost money. Care to invest $10 million? You pay 2% per year and 20% of returns above the S&P 500.
Hypothetically suppose the S&P is up 10% next year. I deliver 20% returns. Alchemy, what can I say. You make $1.6 million, I make $0.4 million (from you), and since I did this in parallel with 100 other people life is pretty grand for me.
Now just between HN and me, my strategy is simple: I buy the S&P 500 as an index but I use 2X leverage.
What would have happened if the market went down 5% next year? Well, we would have lost 10%. That certainly sucks, and you need to make your $1 million back. Which is great, because I am now accepting new money on the Patio11 Chinchilla Fund. It uses complicated financial alchemy to produce market-beating returns, and you only pay if we beat the market. The fund has never lost money.