Two Things about Performance Fees

Institutional investors continue to allocate a significant and growing fraction of their portfolios to alternative investments such as hedge funds, private equity, and real estate, notwithstanding the challenges these relatively illiquid assets posed to them during the financial crisis. Managers of...

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Bibliographic Details
Published inJournal of portfolio management Vol. 38; no. 2; p. 4
Main Author Kritzman, Mark
Format Journal Article
LanguageEnglish
Published London Pageant Media 01.12.2012
Subjects
Asymmetry
Economic crisis
Fees & charges
Institutional investments
Investors
Monte Carlo simulation
Portfolio management
Portfolio performance
Profits
Standard deviation
Volatility
United States > US
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Summary:Institutional investors continue to allocate a significant and growing fraction of their portfolios to alternative investments such as hedge funds, private equity, and real estate, notwithstanding the challenges these relatively illiquid assets posed to them during the financial crisis. Managers of alternative investments typically charge a performance fee chat is a percentage of profits -- but not losses -- relative to a benchmark, along with a base fee that is a fixed percentage of assets under management. With the above assumptions, the asymmetry penalty equals about 0.70%. If the funds' correlations were higher, the penalty would be smaller, and if they were lower, the penalty would be higher. There is yet another subtle and unpleasant feature of performance fees. The standard deviation of funds that charge performance fees understates risk, because it is reduced by the attenuation of upside performance.
ISSN:0095-4918
2168-8656
DOI:10.3905/jpm.2012.38.2.004