This amazing bit of information comes from The Growth Stock Wire and perfectly illustrates why "2 and 20" does not make sense for investors:
We often warn our readers of the impracticality of the "two and 20" most hedge funds charge their clients... That is 2% of total assets and 20% of any gains. This fee structure guarantees the fund manager gets paid regardless of performance.
For example, a manager with $1 billion under management earns $20 million just for walking in the door on January 1. And the 20% "kicker" encourages excessive risk.
A recent article in the British newspaper the Telegraph quantifies how damaging "two and 20" is to the investor using Warren Buffett's historical returns. An excerpt from the article is below:
As you are aware, Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46 per cent per annum. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.8m.
However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2 per cent of the value of the funds as an annual fee plus 20 per cent of any gains, of that $4.8m, $4.4m would belong to him as manager and only $400,000 would belong to you, the investor. And this is the result you would get if your hedge fund manager had equaled Warren Buffett's performance. Believe me, he or she won't.
So, $1,000 invested alongside Buffett earned you $4.8 million over the past 45 years. That same $1,000 invested with Buffett while paying "2 and 20," earns $400,000. I know the numbers seem unbelievable, but it shows you the power of compounding.