Hurdle Rates: The (Missing) Link Between Beta and Hedge Fund Fees
Feb 14th, 2007 | Filed under: Investment Management FeesEver typed Hedge Fund into Wikipedia? Here’s an excerpt of what you get:
“A hedge fund is a private investment fund charging a performance fee and typically open to only a limited number of investors
Funds may also specify a ‘hurdle’, which signifies that the fund will not charge a performance fee until its annualized performance exceeds a benchmark rate, such as USD 90-day T-bills or a fixed percentage. Rules as to what period should be considered for the hurdle vary from fund to fund, but it most commonly covers the current fiscal year.
Sometimes the performance fees are levied only after a performance “Hurdle” has been met. A common practice is to use a hurdle rate linked to short term interest rates, for example 3 month LIBOR in the fund currency. This links performance fees to the ability of the manager to do better than the investor would have done if he had put the money in a bank account.
Though logically appealing, this practice has diminished as demand for hedge funds has outstripped supply and hurdles are now rare.
Note a few salient elements of this definition. Firstly, performance fees are mentioned in the first sentence – suggesting that such fees are an important part of what it means to be a hedge fund. Second, note that the default hurdle rate is a risk-free rate. And third, note that it says hurdles are now rare. We’ll revisit these facts in a moment.
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[…] At the end of the day, long-only performance fees face some of the same accounting challenges that hedge fund performance fees have always faced (e.g. the dreaded “equalization accounting” and other issues contained in this posting). But they go some way toward solving the asymmetry issue. And at least picking the “specified securities index” (a.k.a. beta hurdle, see related posting) is a lot easier with long-only funds than with hedge funds (where the industry is currently groping the dark for indices containing the appropriate blends of various alternative betas). […]