The two primary mechanisms used to ensure performance fees are not paid twice in respect of the same performance in a unitised structure are: ^ Series accounting. This methodology provides for the issuance of a new series of a class of shares as of each investment by each investor on each dealing date in respect of which shares are issued, which provides for a different net asset value for each series. This solution, traditionally more common, is relatively easy to understand and administer, and the results closely match partnership accounting with less complexity than equalisation accounting. ^ Equalisation accounting. Equalisation is more common in European-managed funds, although it is complex, difficult to apply without the appropriate computer programs and can be difficult to explain to investors. It involves investors paying an additional sum at the time of their investment equal to the existing accrual per share in respect of the performance fee where the fund is above its most recent high-water mark, or, where an investor invests in the fund when the fund is below its most recent high-water mark, to make provision for a partial share redemption to fund the performance fee in respect of any application of the net asset value up to the point where the high-water mark is again reached. Dependent upon fund performance, the equalisation amount is subsequently returned to the investor (directly or via additional interests in the fund) or paid to the investment manager. It is not unusual in hedge fund structures for managers to offer multiple classes of share to which different levels of management fee and/ or performance fee apply. Typically, such funds offer investors the opportunity of investing in regular share classes that are subject to standard liquidity terms (e.g., regular redemptions on monthly or quarterly redemption dealing days on thirty days’ notice). As an alternative, investors may be permitted to invest in share classes that are subject to more constrained liquidity terms in return for more attractive (i.e., lower) rates of management and/or performance fees. Such classes may be subject to a minimum “lock-up” period during which redemptions are not permitted, longer notice periods and/ or more limited redemption dealing days. They may also be subject to a higher minimum level of investment per investor. Variants can involve
Accordingly, a fund wishing to invest in new issues may need to establish restricted and unrestricted classes of shares (for restricted and unrestricted persons) in order to allow unrestricted investors to participate in such new issues for so long as such securities remain new issues. Management Class The manager, its personnel and their connected persons may wish to invest in the fund through a “management” class reserved for them (indeed it is usually the case that the lead portfolio manager invests in the fund so as to ensure an alignment of interests). Such management classes often benefit from no management or performance fees or allocations but are otherwise generally subject to similar terms to other investor classes. Fee Structure One of the key aspects of the terms of issue of any hedge fund is fees. Hedge funds typically pay their appointed investment manager a management fee and a performance fee/allocation. The management fee is generally paid monthly or quarterly and is calculated with reference to a specified annual percentage rate of the fund’s net asset value. The annual percentage rate can vary between strategies and share classes. The principle underlying a performance- related fee or allocation (referred to here as a “performance fee”) is that the investment manager should be incentivised as to, and rewarded for, its level of absolute performance calculated by reference to the net asset value of the fund over specified performance periods. Historically, performance periods have been 12-month periods ending on the annual accounting date of a fund, which is often set as December 31 in each year so as to tie in with U.S. tax reporting. However, performance periods can be more or less frequent. Given that the performance fee is calculated with regard to realised and unrealised profits of the fund (as reflected in its published net asset value), most hedge fund terms will provide for underperformance in respect of an investor’s holding in the fund to be carried forward so that performance fees are not paid twice in respect of the same performance. This is generally expressed in terms of a high-water mark or “loss carry forward.”
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