Hedge fund makes money by charging a Management Fee and a Performance Fee.  While these fees differ by fund, they typically run 2% and 20% of assets under management.

Management Fees: This fee is calculated as a percentage of assets under management.  Typically this equates to 2% but can range from 1% to 4% depending on the fund.  These fees are generally paid monthly or quarterly and help pay overhead and daily expenses of running the hedge fund.

Performance Fees: This fee is calculated as a percentage of the funds profits.  This is an incentive fee: if the fund makes money they will get paid, if not they won’t. This incentive fee motives the fund to generate excess returns.  These fees are generally used to pay employee bonuses and reward a hard working staff.

A high water mark helps to protect investors in a scenario where the fund starts to lose money.  This is a loss carryfoward provision that will only be revered if the fund makes back those losses

Assuming a Hedge Fund is $100 million charges standard 2/20% fees and generates 10% annual returns, how much money will the fund make?  The fund would return $4 million in annual fees: Management fee of $2 million plus a $2 million Performance fee ($100mn x 10% x 20%).