Question

416. Hedge fund AlphaBeta has a NAV of $1 million and a zero balance in its cumulative loss account on January 1, 2016.  Now suppose AlphaBeta’s annual performance (net of management fees) is + 13.9% in 2016, +12.6% in 2017, and -19.1% in 2018.  AlphaBeta charges a 20% performance fee.  Based on the high water mark reached in 2017, what minimum percentage gain the does the fund need to achieve in 2019 before performance fees can be taken again?

Answer 1

Given NAV of Alphabeta in 2016: $ 1 Million

Net of management fee, AUM of Alphabeta at the end of 2016, 2017 and 2018 are as follows

AUM (end of 2016): = $ 1 Million*(1+13.9%) = $ 1.139 Million

AUM (end of 2017) = $ 1.139 Million *(1+12.6%) = $ 1.283 Million

AUM (end of 2018) = $ 1.283 Million *(1-19.1%) = $ 1.038 Million

The high water mark for the fund at the end of 2017 = $ 1.283 Million

Now, only when the fund's AUM increases beyond the high water mark which it achieved at the end of 2017, a performance fees can be charged.

Now at the end of 2019, the AUM should be a minimum of $ 1.283 Million, to achieve performance fees

Minimum percentage gain to be achieved in 2019 to achieve performance fees = ($ 1.283 Million/$ 1.038 Million) -1 = 23.61%

Hence the fund needs an annual performance of minimum of 23.61% to increase beyond high water mark achieved in 2017, to earn performance fees again