SIE Understanding Products and Their Risks Question 25: Answer and Explanation

Question: 25

Which of the following aspects of a performance fee is intended to motivate a hedge fund manager to demonstrate consistently higher values?

• A. High water mark
• B. Hurdle rate
• C. Withdrawal fee
• D. Lock-up period

Correct Answer: A

Explanation:

A: The high water mark prohibits performance fees from being paid until a new record high value (for the fund) is attained. Although the hedge fund manager is not charged for a decrease in value, no performance fee will be paid until all losses are recovered by the fund reaching a new record high value. Hurdle rate, Choice B, is a minimum acceptable rate of return but is not intended to motivate a hedge fund manager to constantly increase fund values. Withdrawal fee, Choice C, and lock-up period, Choice D, are methods of discouraging investors from making casual withdrawals, which could frustrate the implementation of long-term strategies, but are not intended to motivate the hedge fund manager.