Tag Archive: investment advisor performance fees

Master Feeder Funds— Background

Posted Sep.13, 2011 under Hedge Fund Administration

A common type of hedge fund structure is called a “master feeder.” A
master feeder fund is (most commonly) a two-tiered investment structure
in which investors deposit capital in a “feeder” fund, which in turn
invests in a “master” fund that is managed by the same investment advisor.
The master fund is the entity that invests in the market as proscribed
by the partnership agreement.

A typical master feeder setup has one master fund with one U.S. (or
onshore) feeder and one Non-U.S. (or offshore) feeder. The benefit of
this organization is that it doesn’t restrict the investing fund to just one
type of investor (that is, tax-exempt versus U.S. taxable).
Feeder funds under the same master can differ in their investor
types, investment minimums, fee structure, net asset values, and other
operational features. Said another way, feeder funds are not tied to a
particular master fund, but rather are their own legal entity. As such, they
are their own partnerships, and can invest in any number of master
funds. The reverse is also true; a master fund is not tied to a feeder, and
can accept investments from any number of feeders.
A master fund, being its own legal entity, is typically an offshore corporation.
An offshore corporation can “check the box” and elect to be
taxed as a partnership for U.S. tax purposes. By investing in an offshore
master feeder fund taxed as a U.S. partnership, the onshore feeder will
receive “pass-through” treatment for its share of the master fund’s P&L.
The investment managers or general partners of offshore funds can be
offshore corporations owned substantially by the fund manager or the
manager’s U.S. entity.

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High water mark method

Posted Sep.11, 2011 under Performance fees

High water mark method

With this “average” method all shareholders are treated like a single pool as incentive fees are charged at the fund’s level without considering the investments’ purchase date or cost. The calculation is said to be asymmetric as performance fees are averaged between all existing investors on the pro-rata basis of their investment.

It tends to be bias to new investors in both cases when the fund’s net asset value goes up or down. It is not representive of individual losses or gains. This problem is compounded, the more volatile a fund is The problem is compounded when a substantial amount of capital entered. In some cases, some investors are overcharged or when others get a free ride. The NAV per share does not represent the real performance of the fund and investors will often have different performance on their investment. Shares are bought and sold at their NAV after deduction of all fees. NAV per share does not represent the performance of the fund Investors who have already paid incentive fees a negatively biased to new shareholders.

The easiness of the calculation as well as being easily understood have made it being quite popular within the industry. A single NAV per share can be reported to all investors, the listing of the fund

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Performance Fees Calculation methods

Posted Sep.11, 2011 under Performance fees

Partnership Method

This is the most sensible method to fairly calculate and allocate carried interest between investors. Ahead of any shareholders’ capital contributions or withdrawals, performance fees are allocated on a pro-rata basis of each investor’s capital at the beginning of the period. Simple to understand and easy to apply, it does not distort the fund’s performance when incentive fees are charged. Investors are only disbursed fees on the performance of their investment; they cannot have a “free ride” or see part of their money being “claw backed” in the fund. However, most investors will shy away of such structure as they will incur income taxes on annual basis as most jurisdictions have lower capital gain than income taxes that they might incur when redeeming their investment.

 The fund has made a gross performance of 20% which solely allocated to partners A as partners B ploughs money into the partnership at the end of the quarter. On June 30th, the fund’s assets have sustained a loss of $510’417 (-20.83%) shared equally between Partners A and B. By the end of the third quarter the net assets stands at $3,713,158, a gain of $773’575 carved out between the three existing partners. The gross ending market value is assessed at $4’022’588 which represents a gross gain of $772’588, the general partners is due $154’518 of incentive fees. The final net assets is $3’868’070 which is also the new HWM.

This is the most sensible method to fairly calculate and allocate carried interest between investors. Ahead of any shareholders’ capital contributions or withdrawals, performance fees are allocated on a pro-rata basis of each investor’s capital at the beginning of the period. Simple to understand and easy to apply, it does not distort the fund’s performance when incentive fees are charged. Investors are only disbursed fees on the performance of their investment; they cannot have a “free ride” or see part of their money being “claw backed” in the fund. However, most investors will shy away of such structure as they will incur income taxes on annual basis as most jurisdictions have lower capital gain than income taxes that they might incur when redeeming their investment.

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