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CFA Level I · CFA Level I Exam · Alternative Investment Performance and Returns

A hedge fund charges a 2% management fee on beginning-of-year assets and a 20% incentive fee on gains. The fund begins the year with $100 million and earns a gross return of 15% before any fees. Management fee is charged first, and the incentive fee is then charged on profits net of the management fee, with no hurdle rate. The investor's net return is closest to:

The net return is about 10.4%. The gross profit of 15 falls by the 2 management fee to 13, then the 20% incentive fee of 2.6 is deducted, leaving 10.4 on 100 invested. The incentive fee is charged on profit after the management fee.

  1. A10.4%Correct
  2. B11.0%
  3. C12.0%

Explanation

Ending value before fees = 115. Management fee = 2. Profit after management fee = 15 - 2 = 13. Incentive fee = 20% x 13 = 2.6. Net profit = 13 - 2.6 = 10.4, so net return = 10.4%. The 12.0% option applies the incentive fee to the gross profit incorrectly, while 11.0% ignores the management fee deduction before the incentive fee calculation.

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