Performance Fees: breakeven active return/standard fee?

CFA Level III Portfolio Management
#1

Trying to decrypt this solution where a fee schedule is shown, and then 4 hypothetical gross returns, asking you to calc net active return:

%
Standard Fee. 0.35
Base Fee. 0.20
Sharing. 0.25 (an active return, beyond base fee)
Breakeven active return 1.25
Max annual Fee. 0.90

Hypothetical Returns:
a. <= 0.20%
b. 0.75%
c. 1.25%
d. 1.75%

Net Active Return (NAR) Answers (in order)
a. Total Fee = 0.20 base fee + sharing (0%). So NAR = <= 0.20 - 0.20 = <=0%
b. Total fee = base + sharing = 0.20 + (.55*.25) = .3375. NAR = 0.75 - 0.3375 = 0.4125%
c. Total fee = return - standard fee = 0.35. NAR = 1.25-0.35 = 0.9%
d. total fee = base + sharing = 0.20 + (1.55*.25) = 0.5875. NAR = 1.75 - 0.5875 = 1.16%

It’s as if you calculate fees the same way every time (base + sharing) except when returns are precisely exactly 1.25%, in which case calculate it some other way, which the CFA readings don’t explain. What does “breakeven active return” and “standard fee” mean?

#2

Where, exactly, is this question?

#3

Reading 27 - Investment Manager Selection
Practice question 40

Very confusing to me too.

#4

ok glad its not just me

1 Like
#5

does in chage incentive fee when the Gross Active Fee is < or = to the Breakeven Active Return?

when is based fee and standard fee charge? what is the diffence between the two?

why when gross active return=breakeven active return, only the standard fee is charged, the incetive fess is not charged?

#6

Anyone who has a “sharing” fee and isn’t a hedgie needs to be out of biz

#7

I’ll take a crack at this Bish. What I think you’re asking about is hurdle fees and overall compensation for the manager.

Let’s say I invest $100k with asset manager X. They may have an “expected return” of 8%. So, if the portfolio returns 10% that year, the manager earns the flat 2% fee no matter what, ($2k) and they gain an extra plus whatever they’ve made on top of that. (10%-the 8% expected). So that extra 2% is subject to the hurdle rate, let’s say 25%. The manager’s total compensation would be the $2k annual assets under management fee, plus 25% of the excess returns, in this case roughly $500 (10% portfolio return-8% hurdle*portfolio value of $100k)=roughly $2500 manager’s comp. Your portfolio value of 110% at the end of the period-$2500 in fees comes out to 107.5% of initial value.

I’m lazy and excluding compounding, it may vary slightly depending on timing of cashflows.

In contrast, if the portfolio only gained 5% during the year, the fee would only result in the 2% AUM charge, so $2k. End port value of roughly 103%

In a few words, I think the difference you’re looking for is just the hurdle rate above the expected 8% ($500 if they achieve 10%). If they don’t outperform, no incentive fee.

I hope this helps, if not, happy to help more, y’all got this.