Hi all, [I hope this is an okay forum to post in] I donât know whether I have confused myself, so seeking the help of people that actually understand math! I am trying to set up some calculations surrounding an Internal Rate of Return ... Or, I think I need an IRR calculation to solve a question.... The question is in relation to calculating returns of an investment share portfolio and calculating possible performance fees. The benchmark out-performance calculation is fine and I am using a Time Weighted Return (TWR); but there is a technicality/criteria that needs to be met by the portfolio for any performance fees to be allowable...... and I am getting confused between two statements and if they mean the same thing or not. Basically, I had this first statement made to a client (the way I think it should be technically done): ***If at the end of any Performance Period the value of your portfolio is lower than your base invested amount, no performance fee shall be payable. The base invested amount will be your initial investment amount if there have been no contributions or withdrawals. The value of your portfolio for a period must be above this initial investment amount or no performance fee shall be payable. If there have been any contributions or withdrawals at any time, an Internal Rate of Return (IRR) for your portfolio from inception will be used to determine if performance fees shall be payable, where a negative IRR will mean no performance fee shall be payable*** But then, somebody looked over the above statement and said that it was way too complicated and that the next statement will give you the exact same outcome: ***If at the end of any Performance Period the value of your portfolio is lower than the total value of your contributions less the total value of your withdrawals no performance fee shall be payable.*** So - are those two statements the same? Is using an IRR making things way over too complicated???? Basically the issue comes, as I understand it, when there has been money put in and taken out AND there actually has been investment performance. I don't want to screw the portfolio manager nor do i want to make things unfair for the client. Basically the client should not be charged any performance fee (even if there is out-performance over a benchmark e.g. portfolio goes down, but benchmark goes down a lot more), there can be no performance fees charged if the clients portfolio is going backwards or is negative to what they have invested. Obviously if they have only put in initial capital, then that is easy as whatever their starting portfolio value was, that is the minimum value allowable for the portfolio to be at that will allow any performance fee .â¦. But how do you determine if their portfolio is going backwards or not if they have put money in, taken money out etc. Hope that makes sense! Thank you for any insight and help Kindest Regards Kaj
A performance fee will be charged at the end of any period whereby the final account balance is greater than the sum of the inital capital at the first day of the period plus interim contributions and less interim withdrawals. If the fee is greater than the change in the final account balance, then the fee is limited to the change in the final account balance.
No they are not the same thing. But the second (suggested by your friend) is a lot less complicated. You choose to go with simplicity which your clients will understand, or try to convince them to go with a value derived from solving a complex mathematical equation. Yes, I understand what you mean by trying to use IRR. I often try to calculate that on my trades, taking account of all deposits/withdrawals and the timing of them. It involves solving for a daily-rate of return that would give me the final balance on account, starting with the opening balance, the withdrawals/deposit (and how many days till year's end was the resulting balance). Once the daily-rate is derived, then compound to one year. I would probably advise to keep it simple in the interest of your client relationship
+1, they're not necessarily the same thing. However, for discrete intervals which aren't too long (1 year, say) I don't think the difference between the two methods will be large (obv, also depends on other factors). I don't, however, understand why it's IRR "from inception", rather than for the period in question.