Present Value of Hedge Fund fees Exercise 1 Investors in Hedge Fund XYZ annually
ID: 2618259 • Letter: P
Question
Present Value of Hedge Fund fees Exercise 1 Investors in Hedge Fund XYZ annually pay a management fee of 2% and an incentive . fee of 20% (HF 2/20) The hedge funds exhibits a NAV of $100 million and earns 17% before fees in year 1 The fund begins year 2 with a NAV of $112 million and again earns 17% before fees The fund is liquidated at the end of year 2 Calculate the present value of (i) the hedge fund and (ii) the hedge fund fees For simplicity assume that . . . - there is no a hurdle rate agreement . the fund earns a constant rate of return (17%) the constant rate of return is used as a discount rate (IRR) for present value (PV) calculationsExplanation / Answer
A Hedge fund is of 2/20 , indicate hedge fund managers charge a flat 2% of total asset value as a management fee and an additional 20% of any profits earned
Exercise 1)
Payment of fees at end of 1 year
Gross earning = NAV * Return = 100 * 17% = $17 Millions
Management fee = 2% * NAV =2% * 100 = $ 2 Millions
Incentive Fee = 20% * Gross HWM = 20% * 15 millions = $ 3millions
Gross HWM = NAV at end of year - NAV at start of year - management fee = 117 -100 -2 = 15 millions
Total fee = Management fee + Incentive fee = 2 + 3 = $ 5 millions
New HWM = Gross HWM - Incentive fee OR NAV at end of year - NAV at start of year - Total Fee
= 15-2 = $ 13 millions
Payment of fees at end of 2nd year
Gross earning = NAV * Return = 112 * 17% = $19.04 Millions
Management fee = 2% * NAV =2% * 112 = $ 2.24 Millions
Incentive Fee = 20% * Gross HWM = 20% * 16.8 millions = $ 3.36millions
Gross HWM = NAV at end of year - NAV at start of year - management fee = 131.04 -112 -2.24 = $16.8 millions
Total fee = Management fee + Incentive fee = 3.36 + 2.24 = $ 5.60 millions
New HWM = Gross HWM - Incentive fee OR NAV at end of year - NAV at start of year - Total Fee
= 16.8 - 3.36 = $ 13.44 millions
So, at the end of 2nd year NAV = 112+13.44 = $ 125.44 millions
PV of Hedge Fund ( liquidating after 2 years , @ 17% ) = End value / ( 1+r)^n
= 125.44 / (1.17^ 2) = $ 91.63561 millions
PV of fee calculated as = fee of first year / ( 1+r) ^1 + fee of 2nd year / ( 1+r) ^1
= 5/1.17 + 5.6/1.17^2 = $ 8.3644 millions
Implication
8.364% of the fund's initial NAV distributed as fee to managers