First-Loss Fee Structures for Hedge Funds

Wednesday, February 18, 2015 - 14:00 to 15:00
703 Thackeray Hall
Speaker Information
David Saunders
University of Waterloo

Abstract or Additional Information

Abstract:  Traditional fee structures for hedge funds involve a flat fee expressed as a percentage of assets under management, together with a performance fee that has the structure of a call option. This structure has disadvantages for investors both in terms of expenses, as well as the incentives it provides for hedge fund managers.  We will discuss a new fee structure that has been adopted by some funds in the industry, referred to as the first-loss fee structure. In this framework, in return for receiving upside participation, the fund manager provides some downside protection against losses to the investors. We show that this fee structure can be formulated as a portfolio of options, and discuss issues regarding pricing and fairness of the fee rates, and incentives and optimal decisions for both investors and hedge fund managers.