The wonders of hedge fund accounting: Incentive fees

(Last Updated On: January 15, 2012)

The wonders of hedge fund accounting: Incentive fees


The mechanics of hedge fund incentive fee accounting tends to lower returns during positive performance months while raising them during negative months, making hedge fund performance seem less volatile than it actually is….


A nice simple analysis of the situation but it is how GAAP requires the reporting of revenue and expenses on an accural basis. This is just a short time frame and most likely would find additional changes in standard deviation if the incenetive fee was all reported at the time of payment. For an extremly successful manager, this would significantly reduce that month’s return and also effect the standard deviation, especially when annual incentive fees are used. It may also further reduce a negative return if in the month of payment the fund had a negative return. A nice start to the analysis but longer timeframe and the effect to the information for month’s where payments are made.

I would be happy to assist if you would like to further the analysis.


If you utilize sophisticated allocation software, enough detailed reports can be generated to provide the investor with an accurate view of what is happening. Most funds will crystallize performance fees annually, though there is no requirement to follow that schedule. But even where funds only crystallize annually, it is appropriate to accrue fees on a break period basis. It is the responsibility of the manager or their admin to insure that investor statements accurately reflect any fee liabilities due to positive performance on a period to date basis. As previous individuals have pointed out, tracking high water marks, which is necessary for lot level accuracy, and including hurdles, which can be tied to any fixed or variable indicator, will further complicate both the calculations and clarity of reporting. Add in equalization methodologies and you have a significant challenge on your hands if you don’t have proven commercial software working for you.



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