Understanding Hedge Fund Fees: Implications for Hedge Fund Managers

LONE PINE MODEL Year One BNAV AUM ENAV BNAV $100 $100 $90 $90 Year Two AUM $110 K&L GATES ENAV $110 In the scenario at the end of Year Two, the sponsor would collect 10% of $90-$110 or $2, whereas if a standard HWM approach had been used, the sponsor would receive 20% of $100-$110 or $2. Because of the risk premium associated with paying below HWM Performance Fees, the HWM increased not from $100 to $1.1.0 but to $115 or $120 (the latter "200% of losses" increase in the HWM is increasingly becoming' market). This means that the sponsor gives up 50% of the Performance Fees on results above what would have been the HWM in return for receiving Performance Fees below the HWM (and, hopefully, being able to retain employees!). Note: it is not profits below the HWM generating Performance Fees that result in increases in the HWM, but simply losses below the HWM. This is because, if a Lone Pine fund's NAV per Share went $100 $90; $90 - $100; $100 - $90; $90 - $100, a 10% Performance Fee would be calculated on both $90 - $100 moves, even though this amounts to double-counting the Performance Fee on the same increases in the NAV per Share. klgates.com 49 49

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