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FRM Part I · FRM Exam Part I · Fund Management

A fund of hedge funds invests $100 million in underlying funds that earn a combined gross return of 12% before any fees at the underlying level. The underlying funds charge a 2% management fee on assets and a 20% incentive fee on profits after the management fee (no hurdle). The fund of funds then charges investors a 1% management fee on its $100 million of assets and no incentive fee. What is the investor's net return, treating all fees as deducted from the return?

The investor nets 7.0%. The underlying funds earn 12%, less a 2% management fee leaves 10%, less a 20% incentive fee of 2% leaves 8%, and the fund of funds' extra 1% fee reduces this to 7.0%.

  1. A7.0%Correct
  2. B8.0%
  3. C7.2%
  4. D6.0%

Explanation

Underlying: 12% - 2% = 10% profit after management fee. Incentive fee = 20% x 10% = 2%. Return after underlying fees = 8%. The fund of funds fee of 1% gives 7.0%. Stopping before the second layer gives 8.0%, and 7.2% results from taking the 20% off the 12% gross incorrectly after only the management fee is deducted on the wrong base.

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