Hedge funds often use complex strategies to achieve outsized returns with low correlation with the broader market. These more complex strategies require more sophisticated portfolio management tools and a larger range of skills, making them more expensive to run. Rather than paying a very high flat management fee, investors demand that some of the compensation is aligned to the performance delivered by the strategy in the form of a performance fee.
Alternative Investment Returns
Custom Fee Arrangements
- Fees based on liquidity terms and asset size
- Founders shares
- “Either/or” fees
Alternative Investment Return Calculations
The impact of different fee arrangements and their effect on the resulting returns to investors is best illustrated using a series of examples. If we assume fixed GP management fees as a percentage of assets under management (AUM) of rm, beginning-of-period assets of P0, end-of-period assets of P1, and a GP performance fee (p) that is a percentage of total return, the GP’s return in currency terms (RGP) is as follows:
RGP = (P1 × rm) + max[0, (P1 – P0) × p].
And we may solve for an investor’s periodic rate of return, ri , as follows:
ri = (P1 – P0 – RGP)/P0.
