# Performance Fees: Call Option on Active Share

Fee Type Hidden Lake Carpenter Management
Base Fee 0.30% 0.18%*
Sharing** 15% 20%
Max Ann. Fee N/A 0.80%
*Min fee.
**On active return, beyond base fee

CFA Question: Identify which manager’s fee structure is most similar to a call option on a
share of active return. Justify your selection.

CFA Answer: Carpenter Management has a bonus-style fee with a maximum fee feature. Bonus-style fees are the close equivalent of a manager’s call option on a share of active
return, for which the base fee is the strike price—for example, the 18 bps base fee,
plus a long call option on active return with a strike price equal to the minimum
(base) fee, minus another (less valuable call option) with a strike price equal to the
maximum fee. Hidden Lake has a symmetrical fee structure in which the manager
is fully exposed to both the downside and upside. So, of the two firms, Carpenter
Management’s fee structure is most similar to a call option.

My questions:

1. Why is it not Hidden Lake? Call options have unlimited upside as far as I know.
2. What about Hidden Lake fees is symmetrical? Only the small 0.3%, versus 15% of active return on the upside. Seems very asymmetrical to me. And how is the manager “fully exposed” to upside and downside? They get 0.30% no matter what, and 15% if things go great…I dont get it
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And on the downside.

No, they don’t.

That’s the point: they have no minimum fee.

I agreed with your first point above. I think the minimum fee seems a “put” option from Carpenter Management’s perspective.

if base fee isn’t a performance fee, and it’s not a minimum fee, then what is it? I thought any non-performance fee is ipso facto a “minimum” fee by the fact that it’s always charged.

Re: the 15% of active return “on the downside”…how does that work? How do you charge 15% fee on negative returns

It appears I’m missing something simple here i just dont know what

Think of it as the intercept term in the formula for a line. If the active return is zero, this is the fee they get. If the active return is above zero, they get this fee plus a share of the active return. If the active return is below zero, they get this fee less a share of the active return.