Understanding Hedge Fund Fees: Implications for Hedge Fund Managers
K&L GATES
UP, UP AND AWAY?
While it may seem primitive to use an overall Performance Fee calculation, this is
clearly the simplest approach, and it is only if a fund has significant downside volatility
that there is a material economic dilution from an overall Performance Fee
calculation. If a fund is always up, an "overall fund" Performance Fee will always
be perfectly fair, assuming that Shares are sold at a NAV reduced by the
accrued Performance Fee. [$100 to $110; New Share at $108; No change to the
end of the period; $218 GAV, Performance Fee, $216 NAV, $108 per Share]. Some
sponsors have reasoned that if they have material downside volatility they will shortly
be out of business anyway, so why not use the simplest calculation method?
In some cases, sponsors have themselves absorbed a portion of the economic
dilution risk of an "overall fund" Performance Fee calculation by agreeing to give
investors a "free ride" - i.e., Shares bought at a NAV below the HWM NAV per Share
pay no Performance Fee until the HWM per Share has been exceeded. However, this
does not address the economic dilution resulting from Shares being purchased at a
NAV reduced by a Performance Fee that is subsequently reversed due to losses (the
benefit of the reversal being properly allocated only to the Shares against which the
Performance Fee was accrued).
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