header bg

Question:

An investment in a hedge fund with a 2-and-20 fee structure has increased in value each period and earned a return of 8% net of management fees in 20x7. Under which of the following provisions would incentive fees for 20x7 be the highest?

A 6% soft hurdle rate and a high water mark provision.
Explaination

With a soft hurdle rate, the incentive fee is a percentage of the entire return once the hurdle rate is met. With a hard hurdle rate, the incentive fee is a percentage of return in excess of the hurdle rate. A high water mark does not affect the incentive fee for an account that has increased in value each period. A soft hurdle rate would result in incentive fees of 20% x 8% = 1.6% of assets; a 5% hard hurdle rate would result in incentive fees of 20% x (8% − 5%) = 0.6% of assets; and a 7% hard hurdle rate would result in incentive fees of 20% x (8% − 7%) = 0.2% of assets.