You have made a $500,000 investment in a hedge fund that has a 2/20 fee structure. The fund has a total of $25 million of assets under management and provides a return of 15% in the first year. Assume that management fees are paid at the beginning of each year and performance fees are paid at the end of each year in which they are applicable. How much will you pay in management and performance fees for the year?
A)$1,000; $11,250
B)$1,000; $12,700
C)$10,000; $11,250
D)$10,000; $12,700
E)$10,000; $15,000

Question

Quizplus · Accepted Answer

The management fee is calculated as 2% of assets under management, which comes out to (2% x $25 million) = $500,000. This fee is paid at the beginning of the year, so the investor will pay $10,000.
The performance fee is calculated as 20% of the gain in the fund. The fund had a return of 15%, so the gain is (15% x $500,000) = $75,000. The performance fee is 20% of this amount, which comes out to $15,000. However, performance fees are only paid if the gain in the fund exceeds the high-water mark, which is the highest level that the fund has previously reached. Since this is the first year of the investment, there is no high-water mark and the performance fee will be paid in full.
Thus, the total fees paid for the year will be $10,000 + $12,700 = $22,700. Therefore, the best choice is D.

You Have Made a $500,000 Investment in a Hedge Fund