Page 47 of the Alternative Investments gives the following example. Kettleside has initial capital of 100 mil, charging a 1% management fee on year-end total assets and a 20% performance fee. In problem 1, they assume a 6% hard-hurdle and performance fees net of management fee as well as a 130 mil year 1 end assets. Total fee comes out to be 5.84, which makes sense. Problem 2 assumes a fee
structure “as specified in Question 1 but also includes the use of a high-water mark”. Using 110 mil year 2 end assets, the formula they employed is 110 million × 1% + max[0, ($110 million – $122.7 million) × 20%]. Wouldn’t we use 130-5.84=124.16 mil as the HWM instead of 122.7? Plus, this calculation does not include hurdle at all. I thought it should be 110 million × 1% + max[0, (110 million – 124.16*1.06 million) × 20%]. Is this an error on CFA or a misunderstanding on my part?
I agree.
I think in question 2 and 3 of example for they have reverted to performance fee being independent on management fee.
We can see example 3 question 1 - assuming no hurdle and independent fees - has closing NAV 122.7
And then to get the 2.34 fees they again assume independence.
I think in question 2 it makes no difference as we are below high water mark
But for question 3 I think we should have fees of 1.792
`128 x 1% + max(0, [128x(1-0.01)-124.16 ] x 20% = 1.28 + 0.512
Right, the performance fee being independent or not is also not consistent. But also, wouldn’t max(0, [128x(1-0.01)-124.16 ] x 20% be watermark only? If hurdle is also used, do we have to multiple 124.16 by 1.06 the hurdle rate?
That is not how the CFA do it. They don’t go into that detail.
But what you describe is a way. Sometimes it is compounded 6% per annum from starting value sometimes 6% from starting, sometimes 6% from highwater mark. There many variations in real world.
And to be clear, HWM is different for each investor and has an initial value of his investment amount right? These examples are making an implicit simplification that one investor holds the whole fund?