Hedge Fund Structure
Compensation

Class Exercise
A fund starts with a value of $100 million in 2009 and the end of the first year this has grown to $120 million
Assume that the hard hurdle rate each year is 4%. In other words performance fee is only charged on returns above the hurdle rate

 The manager collects 20% of $16 million or $3.2 million
 In the following year, 2010, the fund loses money and its value is $115 million at year end. The manager does not get any incentive fee
What is the high-water mark for 2011 (year 3)?

Hedge Fund Structure
Compensation

Class Exercise
A fund starts with a value of $100 million and the end of the first year this has grown to $120 million.
The manager collects 20% of $16 million or $3.2 million. In the following year the fund loses money and its value is $115 million at year end. The manager does not get any incentive fee.
But what is the high-water mark for the following year (year 3)? Assume that the hurdle rate each year is 4%.
High-water mark for year 3 =
Value at end of year 1
+ hurdle rate for year 2
$120,000,000
$120,000,000
$124,800,00

+ 4% * $120,000,000
+ $4,800,000

Thus, the incentive fee would not apply in year 3 until the hedge fund achieved a value in excess of $129.792 million (i.e., the high-water mark plus the hurdle rate).

Marlies van Boven, PhD

Considerations

Advantages

Hedge Funds: Advantages and Considerations






Volatility reduction while earning equity-like returns
Capital protection in down markets
Access to some of the most talented investment managers
Access to specialized strategies not otherwise available (e.g., short selling, arbitrage, distressed investing)



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Limited liquidity
Limited transparency
Use of leverage
Exposure to systemic risk in the financial system
Need for extreme selectivity in choosing managers
Continuous manager monitoring is vital

4

Performance Credit Suisse Hedge Fund Index
Would you invest in hedge funds?
Net Performance Dec 2014, in USD *
Credit Suisse
S&P 500
Hedge Fund Index

Dow Jones World
Index

1 Month
6 Months
1 Year

0.01%
1.26%
4.13%

-0.25%
6.12%
13.69%

-1.88%
-2.98 %
2.12 %

3 Year Cumulative
5 Year Cumulative

23.03%
33.06%

74.60%
105.14%

40.27%
41.39%

Since Inception
3 Year Avg Annual
5 Year Avg Annual

453.92%
7.15%
5.88%

563.40%
20.41%
15.45%

189.01%
11.94
7.17%

Since Inception Avg Annual

8.49%

9.43%

5.18%

*Index data begins January, 1994

5

Performance Credit Suisse Hedge Fund Index
How about based on this information?
Net Performance Dec 2014, in USD*
CS Hedge
Index

S&P 500

Dow Jones
World Index

Average Month
Best Month
Worst Month
Monthly Standard Deviation

0.70%
8.53%
-7.55%
2.07%

0.85%
10.93%
-16.80%
4.32%

0.52%
11.77 %
-19.96 %
4.46%

Annualized Standard Deviation
Sharpe Ratio

7.17%
0.80

14.95%
0.45

15.44
0.16

*Index data begins January, 1994. Sharpe ratio calculated using a rolling 90-Day T-bill rate

6

Performance Credit Suisse Hedge Fund Index
Net Performance 1994 to Dec 2014, in USD
HFR Composite Index
0.050

0.030

0.010

-0.010

-0.030

-0.050

-0.070

012014

012013

012012

012011

012010

012009

012008

012007

012006

012005

012004

012003

012002

012001

012000

011999

011998

011997

011996

011995

011994

S&P was up 28 % in 2013 versus 9.7% Hedge funds
7

Credit Suisse Hedge Fund Index
Annualised Performance

Correlation with S&P 500
Full period
1994-1999
2000-2002
2003-June 2008
July 2008-Oct 2013

0.57
0.59
0.23
0.58
0.80

Date

HFI

SP500

HFI Min

SP500 Min

HFI Max

SP500 Max

1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

21.7%
22.2%
25.9%
-0.4%
23.4%
4.8%
4.4%
3.0%
15.5%
7.8%
7.6%
13.9%
12.6%
-19.1%
18.6%
11.0%
-2.5%
7.7%
9.7%
4.1%

34.1%
20.3%
31.0%
26.7%
19.5%
-10.1%
-13.0%
-23.4%
26.4%
7.1%
3.0%
13.6%
3.5%
-38.5%
23.5%
12.8%
0.0%
13.4%
28.4%
11.6%

-2.0%
-4.1%
-1.6%
-7.6%
-1.3%
-4.6%
-0.8%
-1.4%
0.1%
-0.6%
-1.5%
-1.3%
-1.5%
-6.6%
-0.9%
-2.8%
-3.2%
-1.3%
-1.7%
-0.8%

-0.5%