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Being a hedge fund manager is also potentially profitable because the managers tend to put a large percentage of their own financial net worth in the funds alongside the investors. This is not usually true of other types of managers. So if the fund does well, the hedge fund manager personally does well.

Other features that are common among hedge fund managers—but by no means universal—are the use of leverage and the trading of multiple asset classes. Many have lock-up periods during which investors cannot withdraw their money and a high-water mark that means the manager does not get the incentive fee until any previous losses are made up. While the minimum investment for hedge funds varies considerably, a $500,000 to $1 million minimum investment is typical.

It is the incentive fee that motivates many other fund managers to enter the hedge fund world. In addition to mutual fund managers, economists and proprietary traders have entered the hedge fund arena. Banks such as Goldman Sachs, Daiwa Securities, and Swiss Bank are running in-house funds. Bankers Trust and DLJ have a fund of funds approach.

Fidelity has lost a number of mutual fund managers who defected to the hedge fund world: Jeffrey Vinik, Mary English, Michael Gordon, Mark Kaufman, Andrew Kaplan, and Matt Grech, to name a few recent examples. Erin Sullivan, who had run Fidelity Aggressive Growth Fund with assets of $17 billion and who had generated returns of 103 percent in 1999, started her own hedge fund, Spheric Capital, in early 2000.

The success story was Jeffrey Vinik, who had run Fidelity's Magellan Fund but left to start Vinik Asset Management in 1996. He quickly raised $1 billion. On October 26, 2000, with assets of $4.2 billion, he announced he was returning assets to investors by the end of the year. The reason given was that he and the other two principals—Michael Gordon and Mark Hostetter—wanted to pursue personal interests. Performance had been excellent for the five years he had traded: