101 Concepts for the Level I Exam
Concept 97: Hedge Fund Fees
- The total fee for a hedge fund consists of a management fee and an incentive fee. Common fee structure is 2 and 20 which means 2% management fee and 20% incentive fee.
- Funds of funds charge an additional 1 and 10 fee (1% management fee and 10% incentive fee).
- Incentive fee is usually calculated on profits net of management fees or on profits before management fee.
- Sometimes, the incentive fee is paid only if the returns exceed a hurdle rate.
- In some cases the incentive fee is paid only if the fund has crossed the high watermark. High watermark is the highest value net of fees (or the highest cumulative return) reported by the fund so far. This is to ensure investors do not pay twice for the same performance.
A hedge fund established a high water mark of $200 million two years ago. The end-of-year value before fees for last year was $180 million. This year’s end-of-year value before fees is $210 million. The fund has a ‘2 and 20’ fee structure. Management fees are paid independently of incentive fees and are calculated on end-of-year values. Calculate the total fees of the fund for the current year.
Management fee = 2% of $210 million = $4.2 million
Incentive fee = 20% of ($210 million – $200 million) = $2 million.
Total fees = $4.2 + $2 = $6.2 million