Question

1. You invested $1,250,000 with a market-neutral hedge fund manager. The fee structure is 2/20, and the fund has a high-water mark provision. Suppose the first year the fund manager loses 5 percent, the second year she gains 13 percent, and the third year she gains 7 percent. Assume management fees are paid at the beginning of each year and performance fees are taken at the end of each year.

What are the management and performance fees paid each year?

Answer 1

Year 1 :

Performance Fees : There is not performance fees since the fund manager has negative returns.

Managment Fees : (Total Asset Value * Management Fee ) = $1,250,000 * 0.02 = $25,000

Year 2 :

a) Since Management fees are charged at the beginning of the year and year 1 had loss of 5 %

Total Asset Value = ($1,250,000 - $25,000) * 0.95 = $1,163,750

Management Fees = (Total Asset Value * Management Fee ) = $1,163,750 * 0.02 = $23,275

b) The performance fee is 20% of everything over the $1,250,000 high water mark.

Total Asset Value = ($1,163,750 - $23,275) * 1.13 = $1,288,736.75

Performance Fees = (Profits earned above high water mark * 0.20)
= ($1,288,736.75 - $1,250,000) * 0.20
   = $7,747.35

Year 3

Management Fees = (Total Asset Value * Management Fee ) = ( $1,288,736.75 - $7,747.35) * 0.02 = $25,619.79

Performance Fees

Asset Value at end of year 3 = ( $1,288,736.75 - $7,747.35 - $25,619.79) * 1.07 = $1,343,245.48

Performance Fees =(Profits earned above high water mark * 0.20)
= ($1,343,245.48 - $1,288,736.75) * 0.20 = $10,901.75