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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 year-end assets under management and a 20% incentive fee with no hurdle rate and no high-water mark. The fund starts the year at 100 million and ends at 120 million before fees. Fees are calculated on the year-end value, and the incentive fee is calculated on the gain after the management fee. The investor's net return is closest to:

The net return is about 14.4%. The management fee is 2.4 million, the incentive fee is 20% of the 17.6 million gain after that fee (3.52 million), leaving 114.08 million on 100 million invested, which is the closest option.

  1. A14.4%Correct
  2. B15.5%
  3. C18.0%

Explanation

Management fee = 2% x 120 = 2.4 million. Gain after management fee = 120 - 2.4 - 100 = 17.6 million. Incentive fee = 20% x 17.6 = 3.52 million. Net ending value = 120 - 2.4 - 3.52 = 114.08 million, a net return of 14.08%, closest to 14.4%. Option 15.5% charges the incentive fee on the gain before management fee only partly, and 18.0% subtracts only the incentive fee on 20 million wrongly ignoring the management fee.

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