performance fee, and a high-water mark. The fixed management fee typically ranges from 0 to 2 percent of assets annually. The performance fee is expressed as a percentage of the fund's returns, allowing the hedge fund manager to participate in the fund's returns. Performance fees range from 20 percent to 50 percent of fund returns and are subject to a high-water mark. That is, if the fund's net asset value (NAV) is below the level at which a performance fee was last paid (referred to as the high-water mark), the manager does not receive any performance fee until the fund's NAV once again rises above the high-water mark. The performance fee structure is equivalent to the hedge fund manager owning a proportion of the fund and a put option, where the ownership share is equal to the participation rate of the performance fee. Suppose the performance fee allows the manager to receive 20 percent of the hedge fund's returns. This is analogous to the manager owning 20 percent of the fund. In addition, however, the manager holds a put option on the fund, with a strike price equal to the high-water mark, since the manager does not participate in any losses in the fund. These three characteristics-the lack of constraints, the lack of regulation, and the performance fee-are the common defining features of hedge funds. There are a number of other characteristics that many hedge funds share that affect investors. 11 Lack of transparency. Hedge funds have a reputation for being very secretive, opaque investments. Most will not reveal the assets held, with particular care taken to protect information about short positions. Often, investors will receive periodic letters reviewing performance and exposures, but frequently even leverage is not included in the correspondence. Some of the most guarded funds will not even reveal the types of strategies being managed, let alone the models or trading strategies employed. The secrecy of hedge funds reflects a trade-off between two competing objectives. Investors prefer a high level of transparency so that they can better understand the investment process and the manager's philosophy, and have confidence in the ability of a manager to earn superior returns. Hedge fund managers, though, typically invest in strategies that have limited capacity and are concerned that transparency will lead to increased flow of capital into these strategies, reducing the opportunity to add value. II Short lives. The half-life of hedge funds is about two and a half years (Brown, Goetzmann, and Park 1999). A few funds have failed with large losses and eye-grabbing headlines. More often, the outcome is less dramatic, driven by the fact that most of the potential economics for a hedge fund manager are in the incentive fee. A fund with poor performance, even if modestly positive, may not be viable. When the fund is below its high-water mark, the situation is exacerbated, since the fund has to earn returns-without incentive compensation-simply to get back to even. II Illiquidity. Hedge fund investments are usually illiquid, with redemption windows at least as infrequent as monthly. In addition, redeeming investors must notify the hedge fund manager well in advance of the redemption date, further