Performance Fees for Investment Managers:A comparison of widely used modelsGrigoris AnagnostopoulosConsultant

Investment Manager Performance

The aggregate performance achieved by a fund’s investment manager is typically assessed by its current NAV taking under account: High Water Mark (HWM), i.e. the previously

achieved highest NAV level (end of period) Hurdle Rate, i.e. the return achieved by a

comparable benchmark index, floating, or absolute rate of return

Performance Fee Pitfall #1The Free Ride

Investors who enter in the fund when NAV is below the HWM are erroneously

not charged fees for the performance from the entrance price up to HWM.

On the other hand, investors entered in the fund when NAV is above the HWM

might erroneously pay fees for the performance from the HWM up to the

entrance price.

Performance Fee Pitfall #2The “Claw Back” Syndrome

This scenario occurs when a performance fee has been provisioned due to a temporary NAV increase.

If subsequently the portfolio value decreases below its HWM as new investors enter, then the previous

provision is reverted and credited to all shareholders including those that had not participated in the original

provision.

Example: Evolution of Share Price, High Water Mark, and Hurdle Rates

Calculation methods1. Whole of Fund Method

2. Series of Shares Method3. Equalization Share

Adjustment

1. Whole of Fund MethodWith this method, performance fees are calculated at the fund’s level without considering investors individual returns. The calculation provides asymmetric results since it attributes the performance fees among investors on the pro-rate basis of their investment.

Whole of Fund MethodPros/Cons

CONSPROS

Easy to implement Generates biased results to new investors in both case where NAV is above or under HWM

Easy for investor to understand It is not representative of individual losses or gains.

A single NAV per share can be reported to all shareholders

It does not resolve neither the free ride nor the claw back issues

Example: Whole of Fund Method

NAV Frequency: Monthly Measurement Period: Quarterly HWM: 1000 & no Hurdle rate Monthly Subscriptions: Equal amount of shares for each investor

7,73% Total Return

20% of 77,3 excess return above HWM

Total Fees = fee per share * Holdings

Launch Date Month 1 Month 2 Month 3Monthly Change % 0% 5% 8% -5%

Value 1000 1050 1134 1077,3Fee Rate 20% HWM 1000

Fees Per Share 10 26,8 15,46

NAV Per Share 1000 1040 1107,2 1061,84

Investor Holdings Gross NAV Total Fees NAV NAV / ShareA 1000 1.077.300,00 € 15460 1.061.840,00 € 1.061,84 € B 1000 1.077.300,00 € 15460 1.061.840,00 € 1.061,84 € C 1000 1.077.300,00 € 15460 1.061.840,00 € 1.061,84 €

Perfromance Fees

Gross Asset Value

End of Quarter

Net Asset Value

2. Series of Shares Method

This calculation method requires the issue of new series of shares at each NAV

date where a subscription takes place.

Therefore, on launch date the fund starts by issuing the “Lead series” of shares and

at any subsequent point, a new series will be issued at the same price as the

Lead series.

2. Series of Shares Method…

Each series will have its own performance and the corresponding

performance fee is applied to each series separately.

At the end of the measurement period, each series that has increased in value

above the HWM will be consolidated with the lead series whereas the series

that remained below HWM will continue into the next measurement

period.

Series of Shares MethodPros/Cons

CONSPROS

Depending on the measurement interval, the number of issues can be quite large i.e for Yearly measurement period, a monthly fund can have 12 Series while a daily fund 252 series for each trading day

Accurate and relatively simple to implement

If fund performance is not adequate to overcome the HWM there are many opened series.

Easy for investor to understand It is not possible to report a single NAV per share since each series has its own NAV.

There is no free ride for new investor and it resolves any claw back

syndromes

Time consuming and administratively intense.

Example: Series of Shares Method NAV Frequency: Monthly Measurement Period: Quarterly HWM: 1000 & no Hurdle rate Monthly Subscriptions: Investor A entered at Launch Date, Investor B at the end of

Month 1 and investor C at the end of Month 2

Each series of shares realizes different returns within the quarter

Launch Date Month 1 Month 2 Month 3Monthly Change % 0% 5% 8% -5%

Leading Series 1000 1050 1134 1077,3Series II 1000 1080 1026Series III 1000 950Fee Rate 20% HWM 1000

Leading Series 10 26,8 15,46Series II 0 16 5,2Series III 0 0 0

Leading Series 1000 1040 1107,2 1061,84Series II 1000 1064 1020,8Series III 0 1000 950

Investor Holdings Series Gross NAV per Share Total Fees NAV NAV / ShareA 1000 Leading Series 1.077.300,00 € 15460 1.061.840,00 € 1.061,84 € B 1000 Series II 1.026.000,00 € 5200 1.020.800,00 € 1.020,80 € C 1000 Series III 950.000,00 € 0 950.000,00 € 950,00 €

15,46 per Lead share5,2 per Series II share0 per Series III share

Fees Per Share

Gross Asset Value

Perfromance Fees

7,73 % Total Return2,60 % Total Return

-5 % Total Return

End of Qurter

Net Asset Value

End of Quarter

Each series of shares realizes different returns within the quarter

Different NAV per share for each series Investors pat a fair fee base on the purchase price

3. Equalization Share AdjustmentMethod

Equalization is a sophisticated accounting methodology that ensures all investors and

the investment manager are treated equally and fairly. The conceptual idea is that an

investor who subscribes within the measurement period will receive an

equalization credit/debit depending on the subscription price.

Equalization Share Adjustment…

If the investor subscribed above the current HWM, he will receive a credit for the performance accrued

in the paid NAV price whereas an investor who subscribed below the HWM will receive a debit for

any performance up to the HWM that has not been paid to the fund. At the end of measurement

period, the performance fee is attributed to each shareholder on a pro-rata basis, however the fee is

equalized by converting a portion or all credit/debit in shares for each shareholder. The portion of

unused equalization credit/debit remains for the next measurement period and is payable to

shareholders upon redemption.

Equalization Share Adjustment MethodPros/Cons

CONSPROS

Ensures that all investors are treated fairly

Computationally complex methodology difficult to be digested by investors

Generates a single NAV for the fund

Time consuming and administratively intense without the use of specialized software

There is no free ride for new investor and it resolves any claw back

syndromes

Example: Equalization Share Adjustment NAV Frequency: Monthly, Measurement Period: Quarterly HWM: 1000 & no Hurdle rate Monthly Subscriptions: Each investor gets an equal amount of shares but also gets a credit/debit

depending on subscription price

Credit is used to reduce the fee charge on a pro rata basis to each investor

Credit/Debit = (Subscription Price - HWM)*Fee* Holdings

Single NAV per share for all investors

Launch Date Month 1 Month 2 Month 3Monthly Change % 0% 5% 8% -5%Value 1000 1050 1134 1077,3

Fee Rate 20% HWM 1000

Fees Per Share 10 26,8 15,46

Nav Per Share 1000 1040 1107,2 1061,84

A B CPurchased Shares 1000 1000 1000Credit/Debit - € 8.000,00 € 21.440,00 €

Investor Initial Holdings Gross NAV per Share Total Fees NAV NAV / ShareA 1000 1.077.300,00 € 15.460,00 € 1.061.840,00 € 1.061,84 € B 1000 1.077.300,00 € 15.460,00 € 1.061.840,00 € 1.061,84 € C 1000 1.077.300,00 € 15.460,00 € 1.061.840,00 € 1.061,84 €

Investor Credit/Debit in Use Shares Adjustment Total Holdings Equalized NAV Equalized Fees Paid NAV / ShareA 0 0 1000 1.061.840,00 € 15.460,00 € 1.061,84 € B 8.000,00 € 7,53 1007,53 1.069.840,00 € 7.460,00 € 1.061,84 € C 15.460,00 € 14,56 1014,56 1.077.300,00 € - € 1.061,84 €

End of Qurter

7,73 % Total Return

After Equalization

Perfromance Fees

Gross Asset Value

Subscription & Equalization Credit/Debit

Net Asset Value

End of Quarter

15,46 per share

Investor A: Credit = (1000-1000)*20%*1000Investor B: Credit = (1040-1000)*20%*1000

Investor C: Credit = (1107,2-1000)*20%*1000

Whole of Fund Series of Shares Equalization Shares AdjustmentSingle NAV

&Single Series

Yes No Yes

Communication Straightforward Moderate ComplexCalculation Simple For Each series For each shareholder

End of Period Adjustments

Crystalize fees,Reset HWM &

Hurdle Rate

Crystalize fees, Reset HWM & Hurdle

Rate

Consolidate Series

Crystalize fees, Reset HWM,

Adjust shares for each shareholder, Determine unused Credit & Debit

Recommended No Yes Yes with software

Comparison of Performance Fee calculation methods