LOL! Yes, there are issues with all of this, and I'm going to take back my earlier comment about almost 'getting it'. Firstly, I think one of the calculations earlier is off by a decimal point, and also if you take an example of: Start with 100,000 Loss 5% Get a deposit of 1,000,000 you get a HWM that's hard to live with, seeing as you are only carrying a $5,000 loss. What I am pleased about is that I don't appear to be imagining the difficulties. After stirring up this little hornets nest a good friend sent me this link http://www.hedgefundnews.com/news_n_info/article_detail.php?id=268 which seems to confirm that all is not what may initially meet the eye. But yet again, while being the most authoritative article I have so far read, it doesn't address all situations. Cheers chaffcombe
I didn't want to copy from Excel and paste it here and do all the formatting again, so I just attached it. Take a look at it and see if its right. Thanks. P.S. I read your profile in the Futures Magazine November 2006 edition. Very cool!
Thank you! You've got the correct $125 incentive fee for month 2 if that $500 withdrawal is at the end of month 2. But that's still the easy case again where you are making a withdrawal when you are at an equity peak. Try the same calculation but put the $500 withdrawal at the beginning of Month 2... Highwater mark at the end of month 1 is $5000 and balance is $4500. Withdraw $500 at the beginning of Month 2 and your balance goes down to $4000 and your highwater mark goes down to $4444.44. Then you make a $1000 trading profit in month 2 to get the balance up to $5000. This is $555.56 of new profit above the highwater mark and your incentive fee is $138.89 and the new highwater mark is $4861.11, the balance after your fee is deducted. (The highwater mark and balance would be $5000 if the fee is paid without making a withdrawal from the account.) Do you see how the highwater mark goes down to $4444.44 upon the $500 withdrawal? One way to look at it is that it would take an 11.11% gain to get back up to the highwater mark before the withdrawal, and then after taking out the $500, an 11.11% gain on a $4000 account gets you up to $4444.44, which is the adjusted highwater mark. Of course, you can define how you are going to calculate the highwater mark any way you like in your partnership or management agreement, this is just a standard way where the percentage gain needed to get back up to the highwater mark remains the same after withdrawals in a drawdown. The legalese wording from the partnership agreement of the fund I manage is "The term âLoss Carryforwardâ with respect to any Limited Partner applicable to the Current Month shall mean the cumulative Net Losses, if any, allocated to the Limited Partner for fiscal months prior to the Current Month that have not been offset by subsequent Net Profits. The Loss Carryforward shall be reduced proportionately at each time a withdrawal is made by such Limited Partner to reflect such withdrawals." And then the highwater mark is always just the current balance less the loss carryforward. If it all sounds confusing, it is. Then throw in the added complication of a management fee. Do you deduct the management fee before or after computing the performance fee and how does deducting the management fee affect the highwater mark? Ay Carumba! My advice... Spell it out clearly how things are calculated in your management or partnership agreement and then get your spreadsheet or software set up correctly to calculate it each month, and then you won't ever have to worry about it again. Aaron Schindler Schindler Trading
If your HWM is calculated by Unit Asset Value, it's easy... and Dollars in or out don't even figure into the calculation.
if a fund, u simply apply yr perf fee% to the NAV/share improvement if any from previous period / watermark if managed accts as seems to be your case / example, u look at additional P&L ($) generated by u from previous watermark for the individual acct... all u need to do is adjust the indiv accts' watermark itself, off any deposits/withdrawals/ interest income etc hitting the acct from one period / calculation to the other
There seems to be almost universal agreement that one has to use a percentage or unitized model, and that HWM's are reduced percentage-wise upon redemptions. This, 'taking the loss with them' all makes sense, however, how is new money treated? If you are sitting on a 10% drawdown on a $100,000 account Start $100,000 Now $90,000 HWM $100,000 HWM % therefore 11.11% and you get a deposit of $1,000,000 the percentage model says the New HWM is $1,211,111, and that the new money has a 'free ride' of well over $100,000 in actual dollar profits. New Balance 1,090,000 New HWM 1,090,000 * 1.1111 = 1,211,111 Is this really how the industry operates? BTW I'm asking these questions from both a fund (unit trust style arrangement) and simple managed accounts perspective.
if a fund, new money comes in at a given NAV/share price. if you don't want a headache, either you only allow subscriptions / redemptions on those days (eg mth-end) when you reset the watermark for the next period, OR, if you accept daily intra-period subscriptions for instance, you "publish" / let the investor know what the current NAV/share watermark is for the period and thats's it, he'll be applied the same % as everybody else whether he is investing in a (relative)perf trough or peak or whatever... keep it simple... if not a fund, its as simple as explained in my earlier post
We increase the HWM dollar for dollar with deposits, regardless of whether we are in a drawdown. In the language of our partnership agreement, the "loss carryforward" is unaffected by deposits and the HWM = balance - loss carryforward. In your example the HWM would go to $1,100,000 and the new money does not get a free ride. Aaron Schindler Schindler Trading