# P2.T8.22. High-water marks and hedge fund performance

Discussion in 'Today's Daily Questions' started by David Harper CFA FRM CIPM, Apr 5, 2012.

1. ### David Harper CFA FRM CIPMDavid Harper

AIMs: Explain the fee structure for hedge funds, and the use of high-water marks and hurdle rates. Discuss the academic research on hedge fund performance.

Questions:

22.1. A hedge fund launched with a net asset value (NAV) of $10 million on 1/1/09 and gained +$2.0 million in the first year, net of expenses and managements fees, to reach a NAV of $12.0 million on 12/31/09. As the fund's performance fee is 20.0%, after paying the performance fee of$400,000, the fund's NAV on 1/1/10 was $11.60 million. During calendar 2010, due to poor performance the fund's NAV dropped to$9.0 million as of 12/31/10. Consequently, no performance fee was paid. But the fund rebounded in 2011, ending the year with a NAV of $12.0 million (net of expenses and management fees). Assuming the fund utilizes a standard high-water mark (cumulative loss account), what is the performance fee paid for 2011? a. Zero b.$80,000
c. $400,000 d.$600,000

22.2. In regard to the academic research on hedge fund performance, over the horizon 1990 to 2008 generally, EACH of the following is true according to Stowell EXCEPT for:

a. Hedge funds have exhibited significantly greater volatility than the market; e.g., in comparison to the S&P 500
b. During normal and bull markets, hedge funds matched or slightly outperformed equities; but during unstable periods or bear markets, hedge funds significantly outperformed equities
c. Approximately 3.0% of annual hedge fund returns can be attributed to alpha; however, fund of funds delivered no alpha
d. Top-quartile funds significantly out-performed broad equities consistently and achieved outsized alphas (as high as 15% annually)

22.3. According to Stowell, hedge fund performance data is clouded ("skewed") by a number of biases which, by some estimates, inflates returns by as much as 4.0% if not more. Each of the following correctly illustrates a bias EXCEPT which example is incorrect?

a. A successful fund volunteers to report (participate) in a database, while an unsuccessful fund declines to participate. This is selection bias.
b. An unsuccessful fund was forced to shut down and is therefore not included in the updated database. This is survivorship bias.
c. An unscrupulous fund adjusts its historical runs to show artificially high performance. This is backfill bias.
d. A fund enters final liquidation and consequently stops reporting to the database. This is liquidation bias.
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