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

A hedge fund's investors hold $50 million with a high-water mark of $50 million. Year 1 return is -10% and Year 2 return is +20%, both before fees. The fund charges a 20% incentive fee on gains above the high-water mark and no management fee. Ignoring any hurdle, the Year 2 incentive fee is closest to:

The incentive fee is about $1 million. The fund falls to 45 then rises to 54, but fees apply only to the 4 above the 50 high-water mark. Twenty percent of 4 is 0.8, closest to 1.0.

  1. A$0.0 million
  2. B$1.0 millionCorrect
  3. C$2.0 million

Explanation

After Year 1 value = 45. After Year 2 before fees = 45 x 1.20 = 54. The gain above the high-water mark of 50 is 4. Incentive fee = 20% x 4 = 0.8, which is closest to 1.0. The 2.0 option applies 20% to the 10 gain of 45 to 54 (9 x 20% = 1.8), ignoring the high-water mark; 0.0 wrongly assumes no fee is due.

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