Question

1. How might the incentive fee of a hedge fund affect the manger's proclivity to take on high-risk assets in the portfolio?

2. A hedge fund with $1billion of assets charges a management fee of 2% and an incentive fee of 20% of returns over a money market rate, which currently is 5%. Calculate the total fees, both in dollars and as a percent of assets under management for the following portfolio returns

-5%

0%

5%

10%

3. A hedge fund manages a $2.4billion equity portfolio with a beta of .6. If the S&P contract multiplier is $250 and the index is currently at 1,600, how many contracts should the fund sell to make its overall position market neutral?

Answer 1

1. Incentive fee is received by a manager when the fund outperforms the market. HIgher the incentive fee, higher will be his desire to invest in a fund with high returns. This will encourage him to take on high risk securities in the portfolio and thus raise the overall risk of the fund.

2. Management fee= 2%*1000,000,000= $20,000,000

This is 2% of total assets= 20,000,000/1000,000,000

For the first 3 cases, there is no incentive fees since the fund return in not higher than the market return.

In the 4th case, incentive fee= (10%-5%)*1 billion*20% = 10,000,000

Portfolio return	Management fee	Incentive fee	Total fee	% of assets
-5%	20,000,000		20,000,000	2%
0%	20,000,000		20,000,000	2%
5%	20,000,000		20,000,000	2%
10%	20,000,000	10,000,000.00	30,000,000	3%

3. Total equity= 2400,000,000

Beta= 0.6

S&P multiplier= 250

Index= 1600

Number of contract to be sold= 2400,000,000*0.6/ 250*1600

= 3600