Question

Kaboom Capital is a hedge fund with a fee structure of a 1% maintenance fee of total assets and 20% performance fee for returns in excess of its benchmark. The shop also has a high-water mark on returns above the benchmark. Its returns over a three-year period are listed below.

Year 1 - Fund return 11%, benchmark return 11%

Year 2 – Fund return 8%, benchmark return 10%

Year 3 – Fund return 11%, benchmark return 10%

In which years did the fund managers earn a bonus for performance? Explain.

Answer 1

Kaboom Capital charges 20% performance fee for returns in excess of its benchmark.

In Year -1 the returns earned by the fund was the same as the benchmark return. (11%) Thus Kaboom Capital won't be able to charge it's clients performance fee of 20%; rather it will have to make do with the maintenance fee of 1%

In Year -2 the returns earned by the fund (8%) was lower than the benchmark return (10%). Thus Kaboom Capital won't be able to charge it's clients performance fee of 20%; rather it will have to make do with the maintenance fee of 1%

But in In Year -3 the returns earned by the fund was higher than the benchmark return. Thus Kaboom Capital will be able to charge it's clients performance fee of 20% on the additional 1% (11-10%) return earned by the fund over the benchmark return.

Thus the fund managers earned a bonus for performance in the 3rd Year.