Allocating Annual Incentive Fees Across Monthly Returns

Summary

The document describes a simple way to allocate an annual incentive fee across monthly returns. It defines cumulative return through each month, then measures the portion above a zero baseline, called the above-water cumulative return. The fee attributed to a month is the stated incentive percentage multiplied by the change in this above-water amount from the prior month. Subtracting that fee amount from the month's gross return gives the investor's net return under this approach.

Because the change in the above-water amount can be negative, the monthly fee allocation can also be negative, effectively reversing some prior fee allocation after losses. The example uses a 20% annual incentive fee, but the answer cautions that this is only a simple treatment. Actual fund terms may include additional rules, so the calculation should be checked against the specific manager's fee agreement. The excerpt does not address compounding conventions or other common high-water mark details.

Key ideas

• Track cumulative returns and measure the amount above a zero baseline for each month.
• Attribute the incentive fee to the change in above-water cumulative return during that month.
• Subtract the allocated fee from the gross monthly return to estimate the investor's net return.
• A decline in the above-water amount can produce a negative fee allocation in this simplified method.
• Actual fund fee agreements may require additional rules beyond this calculation.

Tags

# Monthly Return Net of Fees


# Monthly Return Net of Fees












How can I calculate the monthly return net of fees if the fee is annual?For example, if every year there is a 20% incentive fee, is there a formula to adjust the return of each month to compensate for the annual fee?

## Answer by Alex C (score 1)

https://quant.stackexchange.com/a/18358

Let Ri be the monthly returns (R1 for Jan, R2 for Feb, etc)

Let Ci the the cumulative returns (C0= 0, C1=R1, C2=R1+R2, etc)

Let AWCi be the above water cumulative return, defined as AWCi=MAX[0,Ci]

In any month, the manager "receives" 0.2*[AWCi-AWC{i-1}] ; I say receives in quotes because this number can be negative.

Then the investor receives the rest of the return i.e. Ri-0.2*[AWCi-AWC{i-1}]

Note: This is the simplest approach, there can be additional complications, so best find out the rules used by the particular HF in question.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.