1. There are some people who can reliably generate alpha -- returns in excess of the market return -- but those people are rare.
2. It is somewhat difficult to tell who those people are; in particular, at any given time, there are more people who look like they can generate alpha than who actually can.
3. If you are one of the people who can generate alpha, you should charge a fee for your services that is equal to the alpha that you generate.
4. If you are not one of those people, you should charge a fee equal to the alpha that those people generate, because then investors might think that you're one of them.
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By Matt Levine
Here is a simple model for hedge fund fees:
1. There are some people who can reliably generate alpha -- returns in excess of the market return -- but those people are rare.
2. It is somewhat difficult to tell who those people are; in particular, at any given time, there are more people who look like they can generate alpha than who actually can.
3. If you are one of the people who can generate alpha, you should charge a fee for your services that is equal to the alpha that you generate.
4. If you are not one of those people, you should charge a fee equal to the alpha that those people generate, because then investors might think that you're one of them. "