High Water Mark

[Turner737]

Hello,

Can someone confirm if the high water mark is defined before or after the performance fee? I thought it was before, but I just got a practice question wrong because I defined high water as before but the answer used after. I thought it made sense for it to be before but that doesn't seem to be the case.

This was question 22.1 for Stowell on hedge funds.

Thanks

Matt

 

[David Harper CFA FRM]

Hi Matt,

Yes, I agree the whole purpose of the high water mark is to be a test before the performance fee, but isn't that the assumption is my question 22.1?
see http://forum.bionicturtle.com/threads/p2-t8-22-high-water-marks-and-hedge-fund-performance.5614/

(Reminder we are not referring to the management fee, which according to Stowell's Exhibit, is deducted every year regardless of performance)

In this question, the high water mark is invoked only in the final 2011 year, when the fund started the year at $9.0 NAV and a CLA account of -2.6;

• That is, start 2011 with NAV = 9 and high water mark = 9 + 2.6 CLA = $11.6.
• End year with NAV = 12. Without HWM, performance fee would be 20%*(12-9) = $600,000;
  but testing for HWM before returns 20%*(12-11.6) = only $80,000. Let me know you disagree, thanks?

 

[Turner737]

I must have a different thought process because I would have thought there would be zero performance fee in 2011 since the mark of $12b was already reached at the end of 2009.

So from an investor perspective...we invested $10b the HF reached $12 and then took out the 20% of the $2b return. As an investor I would want the high water mark to still be that $12b not the performance adjusted $11.6b. But maybe my thinking is naive and if so I will just have the adjust accordingly. I guess the CLA is post performance fee if I understand you correctly?

What are your thoughts?

Matt

 

[David Harper CFA FRM]

It's a really great point, I didn't see it.

My example follows Stowell (is just a defense): in his exhibit 15.8, his first performance fee of $40,000 does not contribute to the CAL, which to your point, is a way of saying the high water mark (in this method) is set after the performance fee. There are two perspectives, I guess:

• the HWM is defined after the performance fee, in the sense that start-of-year NAVs are net of paid performance fee, but
• the performance fee is only paid after the CAL is restored, which is a way of saying the performance fee is paid after the HWM

I see what you mean, i didn't read you carefully enough, it seems to me this can be interpreted as "HWM is defined after the performance fee" (i.e., as NAV is defined net of performance fee).

I think mine is faithful to Stowell, but as to the investor logic, I could maybe argue either side but I would prefer your side as it appears the performance fee does "double-dips" ... Stowell's example could be wrong

specifically, above, to your point, the managers are effectively twice earning 20% on the difference between 11.6 and 12

.... i don't know market practice. Great observation, thanks,

 

[Turner737]

Okay, I understand and appreciate your insight. I will stick with Stowell in this case considering that is probably going to be the most testable interpretation of this.

Matt

 

[Turner737]

Just saw your add on comments to your post and it was exactly to my point.

Would you still say it is appropriate to stick with Stowell in this case?

Matt

 

[David Harper CFA FRM]

Matt - Yes, in my opinion, from an exam-perspective, we absolutely do always want to let the source text adjudicate.
... you could still be correct: over the years, hundreds of errors with texts have been identified, many have reverted to corrections in subsequent editions

But in the meantime, the assigned text is the basis for GARP's (secondary) check of the questions and the basis for "appeals" if a question is submitted as problematic, so I try not to "go off the range" even when i disagree with the text. Further, in this case, it's not even an issue of conflicting definitions (like we see with IR, for example), so I could submit a "potential error" to GARP (e.g., http://forum.bionicturtle.com/forums/2013-errata.86/) but I don't think its warranted unless it goes beyond interpretation into knowing he's got a mistake (e.g., somebody can definitely say that's not how the CAL works). Thanks,

 

[Turner737]

Perfect, makes sense.

Thanks, David.

Matt

 

[k.simpson]

I have a quick query about the AIMs and this high-water mark concept. Given that the AIM refers to Ch 11 of the text, which uses a more broad-brush approach to describing the HWM, would we be expected to apply the level of detail found in Ch 15 (which you also refer to above)? I found the Ch 15 exhibit through Google Books, since I'm working from the GARP readings.

I'm a bit confused because the (semi-)worked example given in Ch 11 appears to give a different result when worked through using Ch 15 logic. Basically, at the end using Ch 15 logic, I get 2.8 as the performance fee, rather than the 2.0 that is given as the answer.

I don't want to belabour the point, since this is drop in the bucket compared to the volume of this topic, but the apparent inconsistency is throwing me off.

TIA for any reply.

Kamara