Question

A hedge fund with $2.3 billion of assets charges a management fee of 2% and an incentive fee of 15% of returns over a money market rate, which currently is 6.8%. Calculate total fees, both in dollars and as a percent of assets under management, for portfolio returns of: Calculate total fees, both in dollars and as a percent of assets under management, for the portfolio returns in the table below. (Enter your answers for Total Fee ($ millions) in millions not dollars.)

portfolio rate of return total fee (in millions) Total fee (%)
a. -5

b. 0

c. 5

d. 10

Answer 1

We have following information -

Initial investment in hedge fund = $2.3 billion

Management fee on asset = 2%

An incentive fee = 15% of returns over a money market rate

Money market rate = 6.8%.

a. -5%

The hedge fund suffered the loss of 5%; therefore it is not eligible for incentive fee on initial investment

It can earn only management fee on asset which is 2%

Total fee (million $) = Initial investment in hedge fund * management fee

= $2.3 billion * 2%

Or $2300 million * 2% = $46 million

Total fee in Percentage is 2%

b. 0%

The hedge fund’s return is 0%; therefore it is not eligible for incentive fee on initial investment

It can earn only management fee on asset which is 2%

Total fee (million $) = Initial investment in hedge fund * management fee

= $2.3 billion * 2%

Or $2300 million * 2% = $46 million

Total fee in Percentage is 2%

c. 5%

The hedge fund’s return is 5% which is lower than the money market are of 6.8%; therefore it is not eligible for incentive fee on initial investment

It can earn only management fee on asset which is 2%

Total fee (million $) = Initial investment in hedge fund * management fee

= $2.3 billion * 2%                                     

Or $2300 million * 2% = $46 million

Total fee in Percentage is 2%

d. 10%

The hedge fund’s return is 10% which is more than the money market are of 6.8%; therefore it is eligible for incentive fee on initial investment

It can earn management fee on asset which is 2% as well as 15% of returns over a money market rate

Total fee (million $) = Initial investment in hedge fund * management fee + 15% * [(10% - 6.8%) * Initial investment in hedge fund]

= $2.3 billion * 2% + 15% * [(10% - 6.8%)* $2.3 billion]    

= $2300 million * 2% + 15% * [3.2% * $2300 million]

= $46 million + $11.04 million = $57.04 million

Total fee in Percentage = Total fee (million $)/Initial investment in hedge fund

= $57.04 million /$2300 million 0.0248 or 2.48%