Predict two ways that the hedge fund incentive fee may affect a manager’s proclivity to take on
high-risk assets in the portfolio. Support your prediction.
Solution
One of them is the higher water mark, and this is if the portfolio experiences losses, it may not be
able to charge an incentive fee unless and until it recovers to its previous higher value. Another is
when the portfolio is down the manager could choose to take more risk expecting better returns,
so it can not call for incentive fee.
In both the above two cases, if the Manager ask for the the incentive fee to cover the agency
costs, he would be asked to get the higher rate of return which will induce more pressure on its
productivity. In pressure, the portfolio may decline more. The incentive fee could be well asked
at the time when the fund is performing well and having higher returns on its risky portfolios..
Predict two ways that the hedge fund incentive fee may affect a mana.pdf
1. Predict two ways that the hedge fund incentive fee may affect a manager’s proclivity to take on
high-risk assets in the portfolio. Support your prediction.
Solution
One of them is the higher water mark, and this is if the portfolio experiences losses, it may not be
able to charge an incentive fee unless and until it recovers to its previous higher value. Another is
when the portfolio is down the manager could choose to take more risk expecting better returns,
so it can not call for incentive fee.
In both the above two cases, if the Manager ask for the the incentive fee to cover the agency
costs, he would be asked to get the higher rate of return which will induce more pressure on its
productivity. In pressure, the portfolio may decline more. The incentive fee could be well asked
at the time when the fund is performing well and having higher returns on its risky portfolios.
