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Every investor knows this bit of math: if you lose 50%, you need a gain of 100% to recover. It sounds odd, but the math is easy. You have a stock worth $100 and take a 50% loss. It's now worth $50. To get back up to $100, you need to double your money -- that's a 100% gain.
This simple rule is painfully apparent to hedge fund managers right now. While we're all celebrating the big gains they've made this year, the funds themselves understand that there's still a long way to go.
In 2008, the hedge fund industry took a 19% dive, one of the worst years on record for the sector. Over the past nine months, the turnaround has been fantastic, with an industrywide gain of 17% posted. Unfortunately, around 10% of the 8,000 hedge funds on the market will still be well below their high water marks by the end of the year.
Why does this matter? The high water marks are used for the determination of some of the fees that hedge funds charge -- including the 20% of profits generated, which tends to be the real moneymaker (especially in a year like this one, where returns are high). Essentially, the investors need to be made whole on losses before the fund manager is rewarded.
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