Question

1. A fund of funds invests across many hedge funds with an expected return of 8% before fees in a particular year. Hedge funds charge 2% 20% for management and incentives fee, respectively. Fund of fund investors require an expected return of 4%. What type of fee structure (incentive fees and management fees) for the fund of fund delivers an expected return of 4%?

Answer 1

1) Calculation of fee structure:

Let us assume the value of funds at the begining of the year is $100

Value of funds at the end of the year before fee = $100 + $100 * 8%

= $108

Let us assume value of management fees as "x"

Expected return = Expected return before fees - (Value of funds at the end of the year * Management fees) - (Growth in the value of funds during the year * Incentive fees)

4% = 8% - (108 * x) - (8 * 10x)

4% = 8% - 108X - 80X

188X = 4%

X = 4% / 188

= 2.13%

Management fees = 2.13%

Incentive fees = 21.3%