Fees, Charges and Performance Reporting for Portfolio Managers

Understand Fees, Charges and Performance Reporting

Key formulas to remember

Fixed fee

Fixed fee = AUM × fee rate % (for the period)

Charged irrespective of performance. Pro-rate if the period is less than a year.

Performance fee with hard hurdle

Fee = profit share % × (ending value − (opening value × (1 + hurdle)))

Charged only if the ending value is above the hurdle value. Otherwise the fee is nil.

Performance fee with soft hurdle

Fee = profit share % × total profit, if return ≥ hurdle

Once the hurdle is cleared, the share applies to the whole profit. Nothing is due if the hurdle is not met.

Performance fee with high water mark

Fee = profit share % × (ending value − high water mark), if positive

The high water mark is the highest value on which a fee was already paid. Nil fee if the value is at or below it.

Time-weighted rate of return

TWRR = [(1 + r₁) × (1 + r₂) × … × (1 + rₙ)] − 1

Each r is the return of a sub-period between cash flows. Chain the sub-periods by multiplying, not adding.

How to solve Fees, Charges and Performance Reporting questions

1. 1Identify the fee type: fixed, performance or hybrid. Hybrid means calculate both parts and add them.
2. 2Note the base: opening AUM, average AUM or ending value. Use the base the question states.
3. 3If it is a performance fee, find the profit. Subtract any contributions or withdrawals so you use real investment gains.
4. 4Apply the hurdle. For a hard hurdle, charge only on the excess over the hurdle value. For a soft hurdle, charge on the whole profit if the hurdle is met, otherwise nil.
5. 5Apply the high water mark. Charge only on the value above the highest previous mark, then reset the mark after the fee.
6. 6Add expenses if asked for the total cost. Fees and expenses are separate items.
7. 7For return reporting, split the period at each cash flow, compute each sub-period return, and multiply (1 + r) values for TWRR.
8. 8Check the answer against the rule: no fee when the portfolio is below the hurdle or the high water mark.

Quickest way: Hurdle and high water mark in three checks

Common mistakes in Fees, Charges and Performance Reporting

• Charging the performance fee on the whole profit under a hard hurdle.

  Students mix up hard and soft hurdles.

  Fix: Hard hurdle means the fee is only on the excess over the hurdle. Soft hurdle means the fee is on the whole profit once the hurdle is cleared.

• Charging a performance fee when the value recovers to the old peak but not beyond it.

  Students see a gain from the lower value and forget the high water mark.

  Fix: Compare the ending value with the high water mark. Only the amount above it is chargeable.

• Adding sub-period returns to get TWRR.

  Adding feels natural and works roughly for small numbers.

  Fix: Chain the sub-period returns by multiplying (1 + r) and then subtract 1.

• Thinking a fixed fee falls when the portfolio loses money.

  Students confuse fixed fee with performance fee.

  Fix: A fixed fee is a percentage of AUM and is due regardless of performance. Only the performance fee depends on returns.

• Treating expenses as part of the management fee.

  Both reduce the client's returns.

  Fix: Keep them separate. Brokerage, custody, audit and similar costs are actual expenses and must be disclosed apart from the fee.

• Believing a portfolio manager can guarantee a minimum return.

  Hurdle rates sound like a promised return.

  Fix: A hurdle is only a threshold for the performance fee. Guaranteeing returns is not permitted.

Worked examples